factors affecting: price elasticity of demand

Price Elasticity of Demand 📈

Think of price elasticity like a rubber band. If the band stretches a lot when you pull it (high elasticity), the quantity demanded changes a lot when price changes. If it barely stretches (low elasticity), quantity demanded stays almost the same even if price moves.

Key Formula

\$Ed = \dfrac{\% \Delta Qd}{\% \Delta P}\$

Interpretation:

  • \$|E_d| > 1\$ → Elastic demand (big change in quantity)

  • \$|E_d| = 1\$ → Unit‑elastic demand (proportional change)

  • \$|E_d| < 1\$ → Inelastic demand (small change in quantity)

Factors That Make Demand More Elastic

  • Many substitutes available (e.g., Pepsi vs. Coke)

  • Goods are a large part of budget (e.g., fancy cars)

  • Time horizon is long – people can change habits

  • Goods are non‑essential or luxury items

  • High proportion of income spent on the good

Factors That Make Demand Inelastic

  • Few or no substitutes (e.g., insulin)

  • Essential goods (e.g., basic food)

  • Short‑term time horizon (people need the product now)

  • Low proportion of income spent on the good

Exam Tip: When asked to explain why a good is elastic or inelastic, list at least two relevant factors from the bullet points above and give a real‑world example.

Income Elasticity of Demand 💰

Income elasticity tells us how quantity demanded changes when people's income changes. Imagine you get a raise and decide how much of a product to buy.

Key Formula

\$Ei = \dfrac{\% \Delta Qd}{\% \Delta I}\$

Interpretation:

  • \$E_i > 0\$ → Normal good (demand rises with income)

  • \$E_i > 1\$ → Luxury good (demand rises faster than income)

  • \$0 < E_i < 1\$ → Necessity (demand rises but slower than income)

  • \$E_i < 0\$ → Inferior good (demand falls as income rises)

Examples

  • Luxury cars: \$E_i \approx 2\$ – demand doubles when income doubles.

  • Basic bread: \$E_i \approx 0.3\$ – small increase with income.

  • Fast food: \$E_i \approx -0.2\$ – people buy less when they earn more.

Exam Tip: Identify the good’s income elasticity sign and explain what it means for consumer behaviour. Use a real example to support your answer.

Cross Elasticity of Demand 🔀

Cross elasticity measures how the demand for one product changes when the price of another product changes. Think of it as a “price‑reaction” between two goods.

Key Formula

\$E{xy} = \dfrac{\% \Delta Q{dx}}{\% \Delta Py}\$

Interpretation:

  • \$E_{xy} > 0\$ → Substitutes (price rise of y increases demand for x)

  • \$E_{xy} < 0\$ → Complements (price rise of y decreases demand for x)

  • \$E_{xy} = 0\$ → No relationship

Illustrative Table

Good XGood Y\$E_{xy}\$Relationship
CoffeeTea0.6Substitutes
PrinterInk Cartridges-0.8Complements
SodaIce Cream0.0No relationship

Exam Tip: When given a scenario, calculate or estimate the sign of \$E_{xy}\$ and explain whether the goods are substitutes, complements, or unrelated. Support with a quick example.