What is it? Price elasticity of demand (PED) measures how much the quantity demanded of a good changes when its price changes.
Formula: \$E_p = \dfrac{\% \Delta Q}{\% \Delta P}\$
Positive or negative? PED is always negative because of the law of demand, but we usually talk about its absolute value.
| Elasticity Category | |E| > 1 | |E| = 1 | |E| < 1 |
|---|---|---|---|
| Highly Elastic | ✔️ | ❌ | ❌ |
| Unitary Elastic | ❌ | ✔️ | ❌ |
| Highly Inelastic | ❌ | ❌ | ✔️ |
Perfectly Elastic Demand – Imagine a horizontal line on a graph. If the price even changes a tiny bit, quantity demanded jumps to infinity (or drops to zero). Think of a very popular smartphone: if its price goes up even slightly, everyone rushes to buy the cheaper brand.
Perfectly Inelastic Demand – A vertical line. Quantity demanded stays the same no matter the price. Picture life‑saving medicine – you need it whether it costs \$5 or \$500.
Exam Tip: Always state the sign of PED (negative) and then discuss its magnitude. Use the formula and check if |E| > 1, = 1, or < 1 to classify the elasticity.
What is it? Income elasticity of demand (YED) tells us how quantity demanded changes when consumer income changes.
Formula: \$E_y = \dfrac{\% \Delta Q}{\% \Delta I}\$
Positive YED → Normal goods (more income, more demand). Negative YED → Inferior goods (more income, less demand).
| YED Category | > 0 | = 0 | < 0 |
|---|---|---|---|
| Normal Good | ✔️ | ❌ | ❌ |
| Inferior Good | ❌ | ❌ | ✔️ |
Luxury Goods – YED > 1. Example: designer handbags. If income rises by 10%, demand might rise by 20%.
Necessities – 0 < YED < 1. Example: basic food items. Income rise leads to a smaller percentage rise in demand.
Inferior Goods – YED < 0. Example: instant noodles. As people earn more, they buy less of them.
Exam Tip: Identify whether the good is normal or inferior by the sign of YED. If YED > 1, label it a luxury; if 0 < YED < 1, label it a necessity.
What is it? Cross elasticity of demand (XED) measures how the quantity demanded of one good changes when the price of another good changes.
Formula: \$E{xy} = \dfrac{\% \Delta Qx}{\% \Delta P_y}\$
Positive XED → Substitutes. Negative XED → Complements.
| XED Category | > 0 | < 0 |
|---|---|---|
| Substitutes | ✔️ | ❌ |
| Complements | ❌ | ✔️ |
Substitutes Example – Coffee and tea. If coffee price rises, people may buy more tea.
Complements Example – Printers and ink cartridges. If printer price falls, demand for ink may rise.
Exam Tip: When given a price change for Good Y, calculate XED for Good X. A positive value means they are substitutes; a negative value means they are complements.