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Unit 1 Micro Revision
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Unit 1 MicroThe Importance of
Elasticity of Demand
Examiners reward answers that provide
chains of reasoning
These are good connective phrases
by contrast…
A consequence of this might be
…
therefore…
this might
mean… on the other hand…this is because
Diagrams matter!
Diagram must havesFully labeledOriginal and new equilibriumDemand and supply the correct way round Well explained – you must explain why the
curve has shifted, in detailThink about the elasticity – e.g. oil has
inelastic demand and supply
Price Elasticity of Demand
Elasticity Matters!
What do I need to know?The definitions of each elasticityThe formula’s and be confident in using themHow to draw the diagramsThe determinants of PED and PESExamplesWhy they are important
Factors that Affect Price Elasticity
Necessity or luxury?
Availability of substitutes
Consumer income Brand loyalty
Habits Frequency of purchase
Peak and Off-Peak Demand
Peak and Off-Peak: Price & Revenue
Price
Quantity
Price
Quantity
S1
Q1
Q1: Diagram assumes a fixed supply capacity in the market
Q1
S1
D1
Peak and Off-Peak: Price & Revenue
Price
Quantity
Price
Quantity
S1
Q1
Q1: Diagram assumes a fixed supply capacity in the market
Q1
S1
P off-peak D1
Peak and Off-Peak: Price & Revenue
Price
Quantity
Price
Quantity
S1
Q1
Q1: Diagram assumes a fixed supply capacity in the market
Q1
S1
P off-peak D1
D2
Peak and Off-Peak: Price & Revenue
Price
Quantity
Price
Quantity
S1
Q1
Q1: Diagram assumes a fixed supply capacity in the market
Q1
S1
P off-peak D1
D2
P peak
Peak and Off-Peak: Price & Revenue
Price
Quantity
Price
Quantity
S1
Q1
Q1: Diagram assumes a fixed supply capacity in the market
Q1
S1
P off-peak D1
D2
P peak
Cross Price Elasticity of Demand
Cross Price Elasticity of Demand
The price of Good X rises by 20 %. As a result, the demand for a substitute Good Y rises by 10 %. What is the cross-elasticity of demand for Good Y with respect to Good X?
Cross price elasticity
The price of Good X rises by 20 %. As a result, the demand for a substitute Good Y rises by 10 %. What is the cross-elasticity of demand for Good Y with respect to Good X?
Xed = % change in DX / % change in PY= +10% / +20% = +0.5I.e. X and Y are weak substitutes
Cross price elasticity
Using Cross Price Elasticity
The table below gives estimates of the price elasticity’s and cross-elasticities of demand for bus and rail travel. What would be the change in the volume of rail travel resulting from a 25% increase in bus fares?
Using Cross Price Elasticity
The table below gives estimates of the price elasticity’s and cross-elasticities of demand for bus and rail travel. What would be the change in the volume of rail travel resulting from a 25% increase in bus fares? Answer: = +4% (+0.16 x 25)
Income elasticity
Income elasticity of demand
• Normal goods – positive income elasticity• Luxury goods – income elasticity > +1• Necessities – income elasticity >0 and <+1• Inferior products – negative income elasticity• Counter cyclical goods – products whose
demand varies inversely to the macroeconomic cycle – demand rises in a downturn
Income elasticity – counter cyclical products
And for pizza too!
Application of income elasticity
The table shows a consumer's expenditure on a range of goods at different levels of income. For which good does the consumer have an income elasticity of demand greater than zero, but less than one?
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