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IB Economics
Course Companion Chapter 5:
Elasticities
Elasticity of Demand
• PED: Price elasticity of demand
• XED: Cross elasticity of demand
• YED: Income elasticity of demand
PED
• Measures the responsiveness of demand
to a change in price
• Formula
– % change in QD / % change in P
• Example
– If a 5% increase in price leads to a 7%
decrease in QD
– -7/5 = -1.4
• What do the value mean?
What do the values of PED mean?
•
•
•
•
•
PED <1 = price inelastic
PED >1 = price elastic
PED =0 = perfectly price inelastic
PED = = perfectly price elastic
PED =1 = unitry
 PED is positive = giffen or veblen good
 PED is negative = law of demand holds true
 BUT what do these actually mean for my business and
how does it affect the demand curve?
How does PED affect the slope of
the demand curve?
Q
Q
P
P
Q
Q
TASK: draw and label the curves
P
P
Interesting mathematical views of PED
P
More price
elastic
P
P1
Less price
elastic
P2
D
Q1
Q2
Q
PED along a linear D curve
• We are measuring the movements
between points and not the slope
of the entire curve
• Demand curves in reality are
unlikely to be linear
D
Q
A note on UNITRY
• If PED=1 then as price rises
demand falls but revenue remains
constant
• In reality this is very unlikely
• Right angled hyperbola
Determinants of PED
• The number and closeness of substitutes
• The necessity of the price and width of
definition
• The time period considered
Questions to consider
1) What is the PED for cigarettes to a smoker this week?
2) How will your answer change in the longer term?
3) What is the PED for tennis rackets in the summertime in the UK?
PED and taxes
We need to
consider PED when
we impose an
indirect tax – this is
covered in Ch 6
YED
• Measures the responsiveness of demand
to a change in income
• Formula
– % change in QD / % change in Y
• Example
– If a 5% increase in income leads to a 10%
increase in QD
– 10/5 = 2
• What do the value mean?
What do the values of YED mean?
The sign (+/-) is now important
Positive:
• YED <1 = Normal but income inelastic
• YED >1 = Normal but income elastic
Negative
• YED <1 = Inferior but income inelastic
• YED >1 = Inferior but income elastic
 BUT what do these actually mean for my business and
how does it affect the demand curve?
Quantity of potatoes demanded
• Shows the relationship
between income and the
demand for a product
• Named after 19th
Century German
economist ERNST
ENGEL
• As income rises demand
may initially increase
• As incomes rise further
consumers substitute out
into other more
appealing (more
expensive) products e.g.
pasta
CLASS TASK: complete the diagram
Engel Curve
Income
What is XED?
• Measures the responsiveness of QDx to
changes in Py
• Formula
– %age ∆ QPx / %age ∆ Py
• Example
– Say the price of chicken falls by 12% what happens to
the QD of fish?
• What do the sign and value of the calculations
tell us?
– Substitutes or complements
– Close, distant or non-related
What is PES?
• Measures the responsiveness of supply to
changes in price
• Formula
– %∆QS/ %∆P
• Example
– Suppose a 16% fall in price led to a 6% fall in
QS (6/16=0.375)
• PES will almost always be +ve
• What do the values tell us?
How does PES affect the slope of
the supply curve?
Perfectly inelastic supply
P
Perfectly elastic supply
Q
Q
P
Inelastic supply
P
Q
Elastic supply
Q
TASK: draw and label the curves
P
Mathematical considerations of PES
•
•
•
•
•
Any Supply curve that
passes through the origin
mathematically has a
PES=1
Even though S1 and S4
have different steepness
mathematically they both
produce a PES=1
S3: PES > 1
S2; PES <1
HL THINK about tax
S1
S2
P
S3
S4
QS per month
Determinants of PES
• How are costs affected by increases in Q?
• Time period considered
– SR
– LR
– Very short run (immediate)
– Very long run
• Example:
– What is the PES of grain in the US in winter?
Ideas Board