📈 Price Elasticity of Demand
Price elasticity tells us how much the quantity demanded of a product changes when its price changes. Think of it like a rubber band – the more you stretch (price rises), the more it snaps back (quantity falls).
Formula (in LaTeX): \$Ed = \dfrac{\% \Delta Qd}{\% \Delta P}\$
- Elastic (|\$E_d\$| > 1) – a small price change leads to a large quantity change. Example: luxury watches. 📿
- Inelastic (|\$E_d\$| < 1) – quantity hardly changes when price changes. Example: salt. 🧂
- Unitary (|\$E_d\$| = 1) – quantity changes proportionally to price. Example: certain staple foods. 🍞
Decision‑making tip: If a product is elastic, lowering the price can increase total revenue; if inelastic, raising the price may increase revenue.
💰 Income Elasticity of Demand
Income elasticity measures how demand changes when consumers’ income changes. Imagine a pizza slice: the more money you have, the more slices you’ll buy.
Formula: \$EI = \dfrac{\% \Delta Qd}{\% \Delta I}\$
- Normal goods (E_I > 0) – demand rises with income. Example: smartphones. 📱
- Inferior goods (E_I < 0) – demand falls as income rises. Example: instant noodles. 🍜
- Luxury goods (E_I > 1) – demand rises more than proportionally. Example: designer handbags. 👜
Decision‑making tip: For a luxury brand, targeting high‑income markets can boost sales; for an inferior good, focus on lower‑income segments.
🔄 Cross‑Price Elasticity of Demand
Cross elasticity shows how the demand for one product reacts to the price change of another. Think of two shoes: if the price of sneakers drops, people might buy more sneakers instead of boots.
Formula: \$E{xy} = \dfrac{\% \Delta Qx}{\% \Delta P_y}\$
- Substitutes (E_{xy} > 0) – demand for X rises when Y’s price rises. Example: coffee & tea. ☕️🍵
- Complements (E_{xy} < 0) – demand for X falls when Y’s price rises. Example: printers & ink cartridges. 🖨️🖋️
Decision‑making tip: If a product is a substitute, a competitor’s price cut can hurt your sales; if a complement, bundling can boost revenue.
📊 Quick Reference Table
| Elasticity Type | Sign & Magnitude | Example |
|---|
| Price Elasticity | |\$Ed\$| > 1 (elastic), |\$Ed\$| < 1 (inelastic), |\$E_d\$| = 1 (unitary) | Luxury watches (elastic) |
| Income Elasticity | \$EI\$ > 0 (normal), \$EI\$ < 0 (inferior), \$E_I\$ > 1 (luxury) | Smartphones (normal) |
| Cross‑Price Elasticity | \$E{xy}\$ > 0 (substitutes), \$E{xy}\$ < 0 (complements) | Coffee & tea (substitutes) |
📝 Examination Tips
- Always state the formula before plugging in numbers.
- Remember the sign: price elasticity is usually negative (law of demand); income and cross elasticities can be positive or negative.
- Interpret the magnitude: >1 means elastic, <1 means inelastic, =1 means unitary.
- Link the elasticity to revenue: elastic price → lower price ↑ revenue, inelastic price → higher price ↑ revenue.
- For cross elasticity, identify whether goods are substitutes or complements and explain the effect on demand.
- Use real‑world examples to illustrate each case; this shows understanding and helps you remember.
- Check your work: if you get a negative elasticity for a normal good, double‑check your percentage changes.