Elasticity of Demand (Price, Income, Cross)

Overview

Elasticity of Demand is a fundamental concept in economics that measures the responsiveness of quantity demanded to a change in a variable such as price or income. For the OCR GCSE Economics exam, a thorough understanding of Price Elasticity of Demand (PED), Income Elasticity of Demand (YED), and Cross Elasticity of Demand (XED) is crucial. Examiners expect candidates to not only calculate elasticity coefficients but also to interpret their meaning and apply them to real-world scenarios, such as business pricing strategies and government policy decisions. This guide will break down these concepts, provide worked examples, and offer exam-focused advice to help you secure top marks.

Key Concepts

Price Elasticity of Demand (PED)

PED measures how much the quantity demanded of a good changes in response to a change in its price. The formula is:

PED = % Change in Quantity Demanded / % Change in Price

• Elastic Demand (PED > 1): A change in price leads to a more than proportional change in quantity demanded. These are typically luxury goods or goods with many substitutes.
• Inelastic Demand (PED < 1): A change in price leads to a less than proportional change in quantity demanded. These are typically necessities or addictive goods.
• Unitary Elasticity (PED = 1): A change in price leads to a proportional change in quantity demanded.

Income Elasticity of Demand (YED)

YED measures how much the quantity demanded of a good changes in response to a change in consumer income. The formula is:

YED = % Change in Quantity Demanded / % Change in Income

• Normal Goods (YED > 0): As income rises, demand increases.
• Inferior Goods (YED < 0): As income rises, demand decreases.
• Luxury Goods (YED > 1): A type of normal good where an increase in income causes an even bigger increase in demand.

Cross Elasticity of Demand (XED)

XED measures how much the quantity demanded of one good changes in response to a change in the price of another good. The formula is:

XED = % Change in Quantity Demanded of Good A / % Change in Price of Good B

• Substitutes (XED > 0): An increase in the price of one good leads to an increase in demand for the other (e.g., Coke and Pepsi).
• Complements (XED < 0): An increase in the price of one good leads to a decrease in demand for the other (e.g., printers and ink cartridges).

Determinants of PED: The SPLAT Framework

To analyze why a product has a certain PED, use the SPLAT framework:

• Substitutes: The more substitutes, the more elastic.
• Percentage of Income: The higher the percentage of income, the more elastic.
• Luxury or Necessity: Luxuries are elastic; necessities are inelastic.
• Addiction: Addictive goods are inelastic.
• Time: Demand becomes more elastic over time.