2.5 Elasticities of demand

Objective notes

8 learning objectives

2.5.1Concept of elasticity

• Elasticity measures responsiveness between economic variables

• Diagram: relatively elastic and relatively inelastic demand

2.5.2Price elasticity of demand

• PED equals percentage change in quantity demanded divided by percentage change in price

• PED has a theoretical range of values and indicates responsiveness of demand to price

• Calculation: PED, change in price, quantity demanded, or total revenue from data

2.5.3PED diagrams and revenue

• PED can be perfectly elastic, perfectly inelastic, unitary, elastic, or inelastic

• PED affects total revenue when price changes

• Diagram: constant PED cases and unitary PED along a demand curve

• Diagram: revenue changes when demand is price elastic or price inelastic

2.5.4(HL)—PED along a straight-line demand curve

• PED changes along a straight-line downward-sloping demand curve

• Diagram [HL]: PED along a straight-line demand curve

2.5.5Determinants and importance of PED

• PED depends on number and closeness of substitutes, necessity, income proportion, and time

• PED matters for firm pricing and government decision-making

2.5.6(HL)—PED for primary commodities

• Primary commodities generally have lower PED than manufactured products

• Lower substitutability and necessity can reduce responsiveness

2.5.7Income elasticity of demand

• YED equals percentage change in quantity demanded divided by percentage change in income

• Positive YED identifies normal goods; negative YED identifies inferior goods

• YED below one is typical of necessities; YED above one is typical of services and luxury goods

• Diagram: income elastic, income inelastic, and inferior goods on an Engel curve

• Calculation: YED, change in income, or quantity demanded from data

2.5.8(HL)—Importance of YED

• YED helps firms predict demand changes after income changes

• YED helps explain changes in the sectoral structure of an economy