Key Idea: Topic 2.5 covers three types of demand elasticity: PED (price), YED (income), and XED (cross-price). Each measures how responsive quantity demanded is to a change in one variable.
📐 Price elasticity of demand (PED)
PED = \\frac{\\%\\Delta Q_d}{\\%\\Delta P}
- |PED| > 1 → elastic (responsive — flat curve)
- |PED| < 1 → inelastic (unresponsive — steep curve)
- |PED| = 1 → unit elastic (% changes equal)
- |PED| = 0 → perfectly inelastic (vertical)
- |PED| = ∞ → perfectly elastic (horizontal)
🔑 Determinants of PED
- Substitutes — more substitutes → more elastic
- Necessity vs luxury — necessities → inelastic; luxuries → elastic
- Proportion of income — large share → more elastic
- Time — longer time period → more elastic (adjust behaviour)
- Habit/addiction — addictive goods → very inelastic
💰 PED and total revenue
- Elastic demand → lower price → TR rises (volume gain > price loss)
- Inelastic demand → raise price → TR rises (price gain > volume loss)
- Unit elastic → price change → TR unchanged
Firms want to know PED: set prices higher for inelastic goods (petrol) and lower for elastic goods (supermarket sales).
📊 Income elasticity (YED) and cross-price elasticity (XED)
- YED
- %ΔQd ÷ %ΔIncome. Positive = normal good (>1 luxury, 0–1 necessity). Negative = inferior good.
- XED
- %ΔQd of A ÷ %ΔP of B. Positive = substitutes. Negative = complements. ≈ 0 = unrelated.
YED sign tells you the type of good. XED sign tells you the relationship between goods. Always state both the sign AND the magnitude.