Price, income and cross elasticities of demand — Edexcel A-Level Economics A
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Price, income and cross elasticities of demand explained
Elasticity measures how responsive one variable is to a change in another.
Read the full explanation
Price elasticity of demand (PED) compares the percentage change in quantity demanded with the percentage change in price; demand is elastic when the value is greater than 1 in magnitude, inelastic when it is less than 1, and unit elastic at 1. Income elasticity of demand (YED) compares the percentage change in quantity demanded with the percentage change in income; a positive value indicates a normal good, a negative value an inferior good, and a value above 1 suggests a luxury or income-elastic normal good. Cross elasticity of demand (XED) compares the percentage change in quantity demanded of one good with the percentage change in the price of another; a positive value indicates substitutes and a negative value complements.
Your focus
- Define price, income and cross elasticity of demand and state the formula for each.
- Interpret the sign and magnitude of PED, YED and XED values to classify demand conditions and goods.
- Apply elasticity concepts to predict how quantity demanded responds to changes in price, income or the price of a related good.
Price, income and cross elasticities of demand exam tips
Marking Points
- PED is the responsiveness of quantity demanded to a change in the good's own price, calculated as percentage change in quantity demanded divided by percentage change in price.
- Demand is price elastic when the magnitude of PED exceeds 1, price inelastic when it is less than 1, and unit elastic when it equals 1.
- YED is the responsiveness of quantity demanded to a change in income, calculated as percentage change in quantity demanded divided by percentage change in income.
- A positive YED identifies a normal good; a negative YED identifies an inferior good; a YED greater than 1 indicates an income-elastic normal good often called a luxury.
- XED is the responsiveness of quantity demanded of one good to a change in the price of another good, calculated as percentage change in quantity demanded of good A divided by percentage change in price of good B.
- A positive XED identifies substitutes; a negative XED identifies complements; a value near zero suggests weak or no cross-price relationship.
- Elasticity values are interpreted by sign and magnitude, not by the size of the raw numbers alone, and percentage changes should be calculated consistently from the same base.
Examiner Tips
- 💡Read the sign and the magnitude separately: sign tells direction of relationship, magnitude tells strength or type.
- 💡For multiple-choice questions, eliminate options that confuse PED with YED or XED, or that treat a negative value as automatically inelastic.
- 💡Practise interpreting values such as PED = −0.4, YED = 2.5 and XED = −1.2 so you can classify the good and predict the effect quickly.
Common Mistakes
- Misunderstanding: treating a PED of −2 as inelastic because the number is negative. Correction: use the absolute magnitude; a magnitude greater than 1 means elastic demand.
- Misunderstanding: assuming any positive YED means the good is a luxury. Correction: a positive YED only means normal; luxury or income-elastic normal requires YED greater than 1.
- Misunderstanding: reversing the signs for substitutes and complements. Correction: positive XED means substitutes because a rise in the price of one good raises demand for the other; negative XED means complements.
- Misunderstanding: dividing the change by the final value instead of the original value when calculating percentage changes. Correction: use the original value as the base unless the question specifies an alternative method.