Download AS 3.3 unit 2 File

2
35
Elasticity
MARKET FORCES (3.3)
36
MARKET FORCES (3.3)
mind-map
2
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MARKET
MARKET FORCES
FORCES (3.3)
(3.3)
unit over
view
37
37
e
id
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iv
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f ind yo
Demand curves show the relationship between price of a good or service,
and the quantity that consumers are willing and able to buy. Similarly
supply shows the relationship between price and quantity supplied.
This relationship is not the same for all goods or services. Consumers and
producers are more sensitive to changes in the price for some goods or
services, than others.This sensitivity is referred to as elasticity.
This unit looks at three types of elasticity:
•
•
•
price elasticity of demand and supply
income elasticity of demand
cross elasticity of demand
by the end of this unit, you should be able to answer these questions...
1
what is price elasticity and
how do I calculate it?
elasticity
2
what is income elasticity and
how do I calculate it?
3
what is cross elasticity
and how do I calculate it?
2
38
2
MARKET FORCES (3.3)
MARKET
FORCES (3.3)
(3.3)
MARKET
FORCES
39
1
.
2
topilacsticity
pr ice e
name your price
As consumers we are often - but not always very sensitive to price. For example
if commuters pass three petrol stations on the way home, and the one that they
usually buy at raises its price, they will most likely go to another petrol station.
However if the price of pencils rose by 10% would you change brands?
This topic looks at what makes consumers sensitive or not, to changes in price ...
and the implication of this for firms.
producers are sensitive also
The law of supply states that firms are also sensitive to changes in price, but how
much. Just like demand, we can also measure the sensitivity of producers to
changes in price - i.e. their price elasticity of supply.
This topic also shows how to calculate price elasticity of supply, and what factors
affect this.
by the end of this topic, you should be able to...
o describe price elasticity of demand
o compare firms’ revenue to determine price elasticity of demand
o calculate the coefficient of price elasticity of demand
o identify factors that influence price elasticity of demand
o define and calculate price elasticity of supply
o show momentary, short-run and long-run supply
remember - try the exercises and then read the notes to learn what you don’t know.
2
Price Elasticity of Demand
40
MARKET FORCES (3.3)
Imagine two green grocers
, both of whom face the same demand curve. One, however,
specialises in giving extra service (e.g. free deliveries) and so sells less produce but at a higher price. The other
says “forget about service, I want sales, sales, sales” . . . and so sells her produce at cheaper prices. Their products
are otherwise exactly the same and so face the same demand curve.
1. Use the demand schedule below to construct the market demand curve on the axis to the right.
Price
$/kg
QD
($/kg)
(kg/month)
16
14
12
10
8
6
4
1 000
2 000
3 000
4 000
5 000
6 000
7 000
Q
(kg/month)
2. Joe sells his produce at $14/kg. Show this on the graph and label it PJ and QJ .
2
3. Betty sells her produce at $6/kg. Show this on the graph and label it PB and QB .
4. Both Joe and Betty decide to lower their prices by $2/kg. Show this on the graph above.
5. Over the price ranges shown, calculate the coefficient of price elasticity of demand.
____________________________________________________________________________________________
6. Describe the price elasticity of demand over each price range.
$6 - 4
_________________________________________________________________________________
$14 - 12 _________________________________________________________________________________
7. Each producer has changed their price by $2/kg and this has resulted in an increase in quantity of 1 000 kg/
month. Yet the coefficients of elasticity are different. Explain why.
Exercise 2.1
____________________________________________________________________________________________
8. State what each producer should do in terms of their pricing strategy.
Joe
____________________________________________________________________________________
Betty____________________________________________________________________________________
9. Summarise the connection between price elasticity of demand, changes in price and total revenue.
____________________________________________________________________________________________
10.Complete the following table:
Price Range
Elasticity Coefficient
Elasticity
$4 - $6
$6 - $8
$8 - $10
$10 - $12
$12 - $14
$14 - $16
Identify whether the following
different approaches.
41
demand curves are price elastic or inelastic using the
1. Determine whether the lost income or gained income is greater. (Circle your answer.)
2. Calculate the firm’s total revenue before and after the price change.
3. Calculate the coefficient of price elasticity.
$
a. Visual Analysis:
Loss / Gain
is greater
Revenue Analysis:
Before: $___________________
After: $___________________
Coefficient: __________________________________
Demand is price . . .
b. Visual Analysis:
$
50
loss
$
30
gain
D
inelastic / unit elastic / elastic
Loss / Gain is
greater
Price Elasticity & Revenue
MARKET FORCES (3.3)
12
Q
15
2
$
Revenue Analysis:
90c
Before: $___________________
After: $___________________
Coefficient: __________________________________
Demand is price . . .
70c
inelastic / unit elastic / elastic
Loss / Gain is
D
gain
210
Q
270
Exercise 2.2
c. Visual Analysis:
loss
$
greater
Revenue Analysis:
50
Before: $___________________
After: $___________________
Coefficient: __________________________________
Demand is price . . .
loss
30
D
inelastic / unit elastic / elastic
gain
12
30
Q
42
MARKET FORCES (3.3)
Answer the following questions.
Price Elasticity
A student who worked for a pizza takeaway noted that when the company lowered the price of large pizzas
from $14.00 to $11.00, sales increased from 2300 to 3 500 per week.
1. Use the midpoint formula to calculate the price elasticity of demand coefficient for pizzas over the price range
of $14.00 to $11.00. (Show your working.)
Coefficient for price elasticity of demand: _____________ (Rounded to 2 dp).
2. Using your result from (1.), identify whether the demand for pizza is price elastic or price inelastic.
2
Demand for pizza is price: ______________________
3. Suggest the most likely reason for the coefficient you calculated in (1.) above.
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
4. ‘Price-cutting’ by pizza companies to increase sales (and therefore revenue) suggests pizza companies believe
the demand for their pizzas is price elastic. Explain why.
____________________________________________________________________________________________
____________________________________________________________________________________________
Exercise 2.3
____________________________________________________________________________________________
____________________________________________________________________________________________
From 2012 to 2013, the consumption of beef in New Zealand declined by 12% and lamb by 8%. In
the same period, the consumption of chicken increased by 6%.
3. Assume the prices of lamb and beef rose by 4% over the same period of time. Calculate the coefficient for
the price elasticity of demand for beef. Show your workings.
Price Elasticity Coefficient = ________________
4. Assume that the price coefficient calculated in (1.) is correct. What has happened to the Total Revenue of beef
producers?
____________________________________________________________________________________________
43
Answer the following questions.
1. Elasticity of Supply is higher . . .
a.
b.
c.
d.
when fixed costs are low.
when fixed costs are high.
in the short-run.
in the long-run.
2.
The long-run supply curve for a commodity is more elastic than the short-run supply curve because . . .
a. firms can vary all of their inputs in the long-run.
b. the short-run reflects firms entering and exiting the industry.
c. scarcity means the long-run supply is fixed.
d. firms will be at equilibrium in the long-run.
3. From 2009 to 2013, the price of rubber bands rose from $1.30 per box to $1.60 per box. Over the same
period quantity supplied increased from 2 million boxes sold to 3 million boxes sold. Use this information to
calculate the coefficient of price elasticity of supply.
Price Elasticity of Supply
MARKET FORCES (3.3)
PeS = ________________
4. What factors would influence the price elasticity of supply for rubber band suppliers?
____________________________________________________________________________________________
____________________________________________________________________________________________
2
____________________________________________________________________________________________
Alfred Marshall developed the economic theory that price elasticity of supply is linked to time periods.
Graph 1:THE MARKET SUPPLY
FOR LAMB
Sa
P
Sb
Q
5. Assume that lamb prices have increased. With reference to Graph 1, which of the three supply curves for
lamb is the most appropriate for a period of one year?
Supply Curve: _____________________
6. Justify your answer to question 5.
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
Exercise 2.4
Sc
44
MARKET FORCES (3.3)
Price Elasticity
notes
Describe Price Elasticity of Demand (PeD)
Imagine you own a local shop that sells goods for $10 each. Each day you sell 100 goods earning
you $1 000 revenue. If you drop your price by $1, you will increase your sales but will earn less
per good. Should you drop your price?
It depends. You will sell more but because you will earn less per sale, your revenue may fall. You
need to find out whether the increase in sales is greater than the income you lose on existing sales.
Let’s assume that dropping the price by $1 would increase sales by 10% each day. Table 1 below
shows the overall effect of this on revenue.
Table 1: COMPARISON OF REVENUE
Price
Quantity
Revenue
Before
$10
100
$1 000
After
$9
110
$990
The increase in the quantity of sales has not compensated for the loss of income per sale. People
have responded to the drop in price but not sufficiently to increase revenue.
2
How much people react to a change in a factor (such as the price of a good) is called elasticity.
Price elasticity of demand is a specific type of elasticity. It measures how much quantity demanded
changes following a change in the price of a good or service. If demand for a good is price elastic,
this means that consumers are very sensitive to changes in price. Dropping the price will cause
sales to rise enough to generate an increase in total revenue. Conversely, raising the price will
cause quantity demanded to fall so much that total revenue will fall.
If demand is price inelastic, customers are not very sensitive to changes in price, e.g. a price rise
will only see quantity demanded fall slightly. When demand is price inelastic, firms should raise
their prices to increase total revenue.
There are two ways to determine the price elasticity of demand – compare the revenue before and
after a price change or calculate the coefficient of elasticity.
Elasticity:
The sensitivity or responsiveness of quantity demanded or supplied to a change in another factor, e.g. price.
Price Elasticity of Demand: The responsiveness of quantity demanded to
changes in the price.
MARKET FORCES (3.3)
45
Compare Firms’ Revenue to Determine PeD
This approach can best be shown graphically on a demand curve.
$
Figure 2.1 ... Determining Price Elasticity using Revenue
50
In this example, the firm decides to halve its price to
attract more customers.
. . . at $40, QD = 2 . . . Revenue = $80
. . . at $20, QD = 3 . . . Revenue = $60
P1 40
The decrease in price has resulted in revenue falling.
Over the price range of $20 to $40, demand is said to
be ‘price inelastic’.
30
Note: A quick look at the graph will show you the same
thing. The shaded areas represent the revenue lost (light
grey) compared to revenue gained (dark grey). More
revenue is lost than gained.
P2 20
10
D
1
2
Q1
3
Q2
4
Q
• If price falls and revenue falls (or vice versa) then demand is said to be price inelastic.
• If price rises and revenue stays the same, then demand is said to price unit elastic.
• If price falls and revenue rises (or vice versa) then demand is said to be price elastic.
Calculate the Coefficient of PeD
The second approach compares the percentage change in quantity demanded to the percentage
change in price. The most common approach is to use the mid-point approach. The formula for
this is as follows:
QD2 - QD1
Mid-Point Approach:
(QD2 + QD1) ÷ 2
P2 - P1
(P2 + P1) ÷ 2
Repeating the example above but using the mid-point approach to calculating the coefficient of
price elasticity, we get the following results:
3-2
1
(3 + 2) ÷ 2
2.5
0.4
20 - 40
-20
-0.67
(20 + 40) ÷ 2
30
-0.60 (2dp)
This answer tells us that over the price range analysed, demand is price inelastic. You will notice
that the coefficient is negative. This is because the law of demand states that as price rises, quantity
demanded falls (and vice versa), i.e. price and quantity demanded have a negative relationship.
2
46
MARKET FORCES (3.3)
However, we are not concerned about the negative. We are concerned about the size of the coefficient as Table
2 shows:
Coefficient
0  -1
Table 2: PRICE ELASTICITY OF DEMAND
Price Elasticity
Explanation
A rise in price will cause revenue to increase.
Demand is price inelastic.
A fall in price will cause revenue to fall.
Firms should increase price.
rise in price will not affect revenue.
Demand is price unit elastic. A
Firms should not change price.
-1
-1  - ∞
A rise in price will cause revenue to fall.
A fall in price will cause revenue to increase.
Firms should decrease price.
Demand is price elastic.
Note #1
The price elasticity of demand is reflected in the slope of the curve but
does not equal it. Take the example given in Figure 2.2 below.
Figure 2.2 ... Comparing Price Elasticity of Demand
$/unit
2
P1
50
P2
40
This graph shows two price changes. In both cases,
the price drops by $10 and QD rises by 1 unit.
PeD = - 3.0
Despite the change in QD being the same in both
cases, the coefficient of elasticity differs.
This occurs because price elasticity measures the
relative (percentage) changes, not absolute changes.
30
P3
20
P4
10
PeD = - 0.33
D
1
Q1
2
Q2
3
4
Q3
5
Q4
Q
Note #2:
Some simple ways to remember the mid-point formula are:
difference
%∆Q
%∆P
or
average
difference
average
Q
P
Of course these are simplifications of the real formula. Q refers to QD and the percentage change is calculated
using the mid-point approach, not the end-point approach.
MARKET FORCES (3.3)
47
Note #3
Another way to remember the different coefficients of price elasticity is
the following diagram.
$
Figure 2.3 ... Coefficients of Price Elasticity of Demand
I
∞
As PeD tends towards 0 . . . or the
demand curve gets closer to vertical . . .
then demand is price inelastic (I for
inelastic).
E
0
As PeD tends towards ∞ . . . or the
demand curve gets closer to horizontal
. . . then demand is price elastic (E for
elastic).
Q
Like the other memory tricks, be careful with this. It is a memory aid, not an absolute rule.
Identify Factors that Influence PeD
A number of different factors affect the price elasticity of demand. Four main factors that affect price elasticity of
demand are:
1.Necessity of Good / Service
If we must have a good, e.g. water, we will be prepared to pay any price for it ... demand will be
price inelastic.
2.Availability of Substitutes
If there are plenty of substitutes, consumers will be very sensitive to changes in price ... demand
will be price elastic.
3.Price as a Proportion of Income
If the price of the good is small compared to consumers’ income, they are less likely to worry about
changes in price, e.g. the price of salt or coffee ... demand will be price inelastic.
4.Time Period
The longer the time frame that we consider, the more able consumers are to find a substitute for a good or
service. Therefore they are less willing to pay a higher price for a good.
2
48
MARKET FORCES (3.3)
Define and Calculate Price Elasticity of Supply (PeS)
We also need to consider the price elasticity of supply. Price elasticity of supply tells us how able
suppliers are to increase production in response to an increase in price (or vice versa).
Price elasticity of supply is also calculated using the mid-point approach, as shown below:
QS2 - QS1
(QS2 + QS1) ÷ 2
Mid-Point Approach:
P2 - P1
(P2 + P1) ÷ 2
Show Momentary, Short-Run and Long-Run Supply
The responsiveness of supply depends on the availability of resources. If firms find it difficult to get
extra resources or to reduce the resources they use (e.g. labour) then supply will be price inelastic,
i.e. firms find it difficult to respond to changes in price.
The amount of time that suppliers have to respond to a price change greatly affects the elasticity of
supply. There are three time periods to consider when analysing the price elasticity of supply:
2
Momentary Supply
This refers to a firm’s ability to change output immediately (within the next few minutes or hours). Because firms cannot do this, momentary supply is shown as perfectly inelastic.
Short-Run Supply
In the short-run, firms can change some but not all resources. This means that they have some
ability to change output in response to a change in price.
Long-Run Supply
In the long-run, all factors of production (resources) are variable. If consumers want more of a good
or service, firms can meet their wants. Long-run supply is shown as elastic.
$
Figure 2.4 ... Price Elasticity of Supply
Momentary
Supply
Short-Run
Supply
The price elasticity of supply changes according to
the time period.
This graph summarises the three types of supply
curve - momentary, short-run and long-run.
Long-Run
Supply
Q
Momentary supply is perfectly price inelastic. In
contrast long-run supply is typically price elastic as
all resources are variable.
MARKET FORCES (3.3)
MARKET FORCES (3.3)
income
&
49
49
2
.
2
c
i
top
mand
e
d
f
o
y
sticit
ela
s
s
o
r
c
if I were a rich man ...
How and what consumers buy is also influence by their income. Income
elasticity of demand (YeD) measures how sensitive consumers’ demand is to a
change in their income.
X marks the spot
A third form of elasticty is cross elasticity (XeD). This measures how sensitive
consumers’ demand is to changes in the price of other goods or services.
As we will see, this helps us determine whether goods are complements,
substitutes or independent.
by the end of this topic, you should be able to...
o define and calculate income elasticity of demand (YeD)
o describe inferior, normal and luxury goods
o show YeD on a demand graph
o define and calculate cross elasticity of demand (XeD)
o describe complements, substitutes, and independent goods
o show XeD on a demand graph
remember - try the exercises and then read the notes to learn what you don’t know.
2
Income Elasticity of Demand
50
MARKET FORCES (3.3)
Calculate the income elasticity of the following goods and then place them on the
continuum below.
Bach
Muesli
(5% rise in income . . . 13% rise in sales)
(8% rise in income . . . 19% rise in sales)
YeD = _______
YeD = _______
House
Bananas
(5% rise in income . . . 7% rise in sales)
(2% rise in income . . . 1.4% rise in sales)
YeD = _______
YeD = _______
Kitset Vegetable Garden
Barbeque
(5% fall in income . . . 4% rise in sales)
(10% rise in income . . . 23% rise in sales)
YeD = _______
YeD = _______
2
INFERIOR GOODS
NORMAL GOODS
luxury goods
0
1
1. When we draw price elasticity of demand, we compare two points on a demand curve. How would you
show income elasticity? On the graph below, show changes to the demand curve that illustrate the income
elasticity of demand for barbeques and bananas (nb scale is not important).
Bananas
Barbeques
$
Exercise 2.5
$
P1
P1
D
Q1
D
Q
Q1
Q
2. Identify two firms that sell what you would consider to be luxury goods and how they would respond if the
Government were to announce income tax cuts.
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
51
Cross-Elasticity
is a very important concept for businesses to understand.
Take a supermarket for example, where the costs of the products they get in vary from
day-to-day and week-to-week. Managers in this setting have to be very careful that dropping the price of one
good does not adversely affect sales of other goods or brands.
1. Calculate the cross-elasticity of the following products sold at Waitakere MegaValue Hypermarket and
determine their economic relationship.
Bananas and Grapes
(bananas fell from $2.00/kg to $1.60/kg . . . sales of grapes fell 4%)
XeD = ____________
Grapes and Bananas are ____________________
Instant Coffee and Plunger Coffee
(the price of plunger coffee rose by 12% . . . sales of instant coffee rose by 5%)
XeD = ____________
Instant Coffee and Plunger Coffee are ____________________
Rat Poison and Ginger Beer
(the price of rat poison rose by 8% . . . sales of ginger beer rose by 0.02%)
XeD = ____________
Cross Elasticity of Demand
MARKET FORCES (3.3)
2
Rat Poison and Ginger beer are ____________________
2. Even though independent goods (e.g. _________________ and _________________) have no cross elasticity,
the change in the price of one could still affect the demand for other goods. For example, how could the price
of houses affect the demand for yachts even though they are independent?
____________________________________________________________________________________________
3. Identify and explain the cross-elasticity of demand between chips and drinks sold in a bar:
Elasticity: _________________________________________________________________________________
Explanation:_________________________________________________________________________________
_________________________________________________________________________________
4. In your own words, explain why a firm that sells multiple goods or services (e.g. a supermarket), must be
aware of the cross-elasticity of its various products. Your answer should clearly refer to the firm’s revenue.
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
Exercise 2.6
____________________________________________________________________________________________
Income & Cross Elasticity
52
MARKET FORCES (3.3)
Income
and cross elasticity are important factors for firms when deciding
their marketing strategies.
1. Draw a line to match the type of elasticity of demand with the most appropriate type of goods.
ELASTICITY
TYPE OF GOODS
Price elasticity is largeComplements
Income elasticity is positive Expensive goods (relative to income)
Income elasticity is negativeInferior goods
Cross elasticity is positiveNormal goods
Cross elasticity is negativeSubstitutes
2. During an economic downturn, demand for restaurants decreases and demand for takeaways increases.
Explain why this occurs, and what it indicates about the income elasticity of demand for these goods.
____________________________________________________________________________________________
2
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
3. Explain why some goods have a higher income elasticity of demand than others.
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
Exercise 2.7
____________________________________________________________________________________________
____________________________________________________________________________________________
4. What factors would affect the cross elasticity of two (or more) goods or services?
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
53
Answer the following multiple choice questions:
1. Suppose that an increase in consumer income of 5% causes the consumption of a particular good to fall from
10 to 6 units. The income elasticity of demand is:
a.-10
b.-6
c.5
d.6
2.
An inferior good is one for which . . .
a. the quantity demanded will only increase if the price falls.
b. a higher price has relatively little effect on the quantity demanded.
c. the income elasticity is positive but less than 1.
d. an increase in income results in a lower quantity demanded.
3.
Which of the following goods would be most likely to have an income elasticity of greater than one?
a. Wine
b.Cigarettes
c. White bread
d.Heating
Define the following terms. Check that you can define each term and use it in an appropriate context.
complementary goods______________________________________________________________________
______________________________________________________________________
cross elasticity of demand
______________________________________________________________________
______________________________________________________________________
Income & Cross Elasticity
MARKET FORCES (3.3)
2
income elasticity of demand ______________________________________________________________________
______________________________________________________________________
independent goods______________________________________________________________________
______________________________________________________________________
______________________________________________________________________
normal good______________________________________________________________________
______________________________________________________________________
substitute goods______________________________________________________________________
______________________________________________________________________
Exercise 2.8
inferior good______________________________________________________________________
54
MARKET FORCES (3.3)
Income & Cross Elasticity of Demand
notes
Define and Calculate Income Elasticity of Demand (YeD)
Income elasticity of demand is calculated using the mid-point approach but we use changes in
income rather than price. The formula is given below.
Q D2 - Q D1
(QD2 + QD1) ÷ 2
Mid-Point Approach:
Y2 - Y 1
(Y2 + Y1) ÷ 2
Describe Inferior, Normal and Luxury Goods
The results you get for the coefficient for income elasticity may be either positive or negative. Table
3 summarises the significance of the coefficient of income elasticity.
2
Coefficient
Table 3: INCOME ELASTICITY OF DEMAND
Price Elasticity
Explanation
YeD < 0
Good is inferior.
A rise in income causes demand to fall.
A fall in income will cause demand to rise.
0 < Y eD
Good is normal.
A rise in income causes demand to rise.
A fall in income will cause demand to fall.
Good is necessity.
A rise in income causes demand to rise slightly.
A fall in income will cause demand to fall slightly.
Good is luxury.
A rise in income causes demand to rise a lot.
A fall in income will cause demand to fall a lot.
0 < YeD < 1
1 < Y eD
Show YeD on Demand Curves
Income elasticity refers to the
impact of a non-price factor
on demand, i.e. a change in
income results in a shift of the
entire demand curve.
Figure 2.5 ... Income Elasticity of Demand
$/unit
P1
Income elasticity refers to how
much the entire demand curve
shifts, as shown in Figure 2.5.
D1
An increase of income
results in a shift of demand
to the right. The size of the
shift illustrates the income
elasticity of demand.
D
Q1
Q2
Q
Define and Calculate Cross Elasticity of Demand (XeD)
Income Elasticity of Demand: The responsiveness of demand to changes in
the income.
Cross elasticity of demand is used to compare the impact of another good’s price on the demand for
MARKET FORCES (3.3)
55
a good or service. This is particularly relevant in large stores such as supermarkets. For example,
lowering the price of pears may result in decreased apple sales. Alternatively, lowering the price of
paper plates, may result in more sales of plastic knives and forks.
We use the mid-point approach to calculate cross elasticity but use changes in the price of the
second good. The formula is as follows:
QDA2 - QDA1
Mid-Point Approach:
(QDA2 + QDA1) ÷ 2
PB2 - PB1
(PB2 + PB1) ÷ 2
Describe Complements, Substitutes and Independent Goods
The results you get for the coefficient for cross elasticity may be either positive or negative. Table
4 summarises the significance of the coefficient of cross elasticity.
Coefficient
Table 4: CROSS ELASTICITY OF DEMAND
Price Elasticity
Explanation
XeD < 0
The two goods are
complements.
A rise in the price of the other good will cause
demand of this good to fall (and vice versa).
XeD = 0
The two goods are
independent.
A rise in the price of the other good will have no
effect on demand for this good.
XeD > 1
The two goods are
substitutes.
A rise in the price of the other good will cause
demand of this good to rise (and vice versa).
Show XeD on Demand Curves
Like income elasticity,
cross-elasticity is illustrated
on a demand curve as a
shift of the whole demand
curve. The larger the shift
due to a change in price of
another good or service, the
greater the cross elasticity of
demand.
Figure 2.6 ... Cross Elasticity of Demand
$/unit
P1
D1
D
Q1
Q2
Q
An increase of the price of a
substitute causes demand for
a good to shift to the right,
as consumers buy less of the
substitute and more of this
good.
The size of the shift illustrates
the income elasticity of
demand.
Cross Elasticity of Demand: The responsiveness of demand for one good to a
change in the price of another good.
2
56
MARKET FORCES (3.3)
UNIT 2
Elasticity
Unit Content:
Understanding
1
(poor)
2
2.1 Price Elasticity
• Describe Price Elasticity of Demand (PeD)
• Compare Firms’ Revenue to PeD
• Calculate the Coefficient of PeD
• Identify Factors that Influence PeD
• Define and Caluclate Price Elasticity of Supply (PeS)
• Show Momentary, Short-Run and Long-Run Supply
2.2 Income and Cross Elasticity of Demand
• Define and Calculate Income Elasticity of Demand
• Describe Inferior, Normal and Luxuray Goods
• Show Income Elasticity on Demand Curves
• Define and Calculate Cross Elasticity of Demand
• Describe Complements, Substitutes and Independent Goods
2
• Show Cross Elasticity on Demand Curves
checklist:
I have ...
 done a mind-map of the main ideas (before and after I’ve done the work)
 tried (and marked) all of the exercises
 watched the online videos of this work
 read the notes and summarised the key ideas in the margins of the pages
 made (or downloaded from quizlet) flashcards of the key ideas and definitions
relevant current events and examples:
relevant events and examples for this unit are:
I didn’t really get the following parts of this unit ...
... and I’m going to ask ___________________ to help me with this
3
(good)