When prices change, how do consumers and businesses respond? Do they immediately stop buying, or does it take a major price hike to change behavior? And how do income changes affect what we buy?
The concept of elasticity helps answer these questions. Elasticity measures how sensitive demand or supply is to price, income, or the price of other goods. In this blog, we’ll explore the key types of elasticity you need to know for A-Level Economics. These types include Price Elasticity of Demand (PED) and Price Elasticity of Supply (PES). They also encompass Income Elasticity of Demand (YED) and Cross Elasticity of Demand (XED). We’ll use real-world examples to explain how businesses and governments use these concepts in everyday decision-making.
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FAQs
What is price elasticity of demand (PED)?
Price elasticity of demand measures how the quantity demanded of a good responds to a change in its price. If demand is elastic, a small price change will lead to a larger change in quantity demanded. If demand is inelastic, quantity demanded will not change significantly with price changes.
How do businesses use elasticity in their pricing strategies?
Businesses analyse elasticity to determine how to price their products. For goods with inelastic demand, companies can raise prices without losing many customers. Conversely, for goods with elastic demand, companies must be cautious with price increases. They may cause a significant drop in sales.
What is the difference between income elasticity of demand (YED) and cross elasticity of demand (XED)?
Income elasticity of demand measures how the quantity demanded of a good shifts. This change happens in response to a change in consumer income. In contrast, cross elasticity of demand shows the effect of the price of one good. It impacts the quantity demanded of another good. YED helps identify normal and inferior goods, while XED helps identify substitutes and complements.
Can you give an example of inelastic and elastic supply?
An example of inelastic supply is agricultural products, such as wheat. Farmers cannot quickly increase production when prices rise due to growing seasons and land limitations. On the other hand, the supply of smartphones is considered elastic. Manufacturers can increase production quickly by adding shifts. They can also use existing resources more efficiently.
Why is understanding elasticity important for government policy?
Understanding elasticity helps governments design effective tax and welfare policies. They may impose higher taxes on goods with inelastic demand. Cigarettes are an example of such goods. This approach raises revenue without significantly decreasing consumption. Additionally, knowing income elasticity helps governments forecast how different groups will be affected by economic changes, guiding their support.
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