Elasticities of Demand
Economics: IB Diploma, topic 1.2.1
Elasticity
Elasticity measures the responsiveness of one variable to the change in another variable.
Price elasticity of demand (PED)
- Price elasticity = % change in quantity demanded ÷ % change in price.
- Elastic demand is where the PED > 1.
- Inelastic demand is where the PED < 1.
- Unitary elasticity is where the PED = 1.
- PED is almost always negative as an increase in price would result in a decrease in demand. But you may see some questions refer to it as positive for ease.
Income elasticity of demand (YED)
- Income elasticity of demand = % change in quantity demanded ÷ % change in income.
- Normal goods have a positive income elasticity, YED > 0 (income rises; demand increases).
- Inferior goods have negative income elasticity, YED < 0 (income rises; demand decreases).
- For example, those with higher income may buy fewer burgers and more steaks. Burgers in this case are an inferior good.
- YED can be positive or negative.
Cross-price elasticity of demand (XED)
- Cross-price elasticity of demand is when a change in the price of one good can change the quantity demanded of another.
- Cross-price elasticity of demand = % change in quantity demanded of good A ÷ % change in the price of good B.
- XED is positive if the goods are substitutes and negative if the goods are complements - you can work this out for yourself but also try to remember it!
- If XED is close to zero this would suggest that the goods are unrelated.
Complement Goods vs Substitute Goods
The cross-price elasticity of demand (XED) for complements is negative because a fall in the price of one good will increase the quantity demanded for the other good.
Complement goods
- For complements, a fall in the price of one good will lead to an increase in the quantity demanded for the other good. Complements have negative cross-price elasticities of demand.
- E.g. peanut butter and bread.
- E.g ice cream and sun cream.
- XED < 0
Substitute goods
- For, substitutes, a fall in the price of one will lead to a fall in the quantity demanded of the other. Substitutes have positive cross elasticities of demand.
- E.g. coffee and tea.
- XED > 0
Independent goods
- Independent goods have a cross-price elasticity of demand of zero.
- E.g donkeys and ice cream.
- XED = 0
Test yourself on Elasticities of Demand
What is another way to describe elasticity?
Why might the demand for burgers go up in a recession?
Which of these could be a complement to peanut butter?
In the context of economic theory, which of these could be a substitute for school?