Carefully Explain What It Is That Price, Income and Cross Elasticities of Demand Are Meant to Measure. Use Appropriate Diagrams and Numerical Examples.

Topics: Supply and demand, Consumer theory, Price elasticity of demand Pages: 3 (961 words) Published: December 27, 2010
Elasticity is a measure of responsiveness. It shows us how much something changes when there is another change in one of the other variables that determines it. There are three elasticities of demand that we consider, price elasticity of demand (PED), income elasticity of demand (YED) and cross elasticity of demand (XED). An important aspect of a product’s demand curve is how much the quantity demanded changes when price is changed. The economic measure of this response in the price elasticity of demand (PED). It is most commonly calculated with the following equation: PED = % change in quantity demanded of the product

% change in price of product
The above formula will usually give a negative value, due to the inverse nature of the relationship between price and quantity demanded. This is given, and explained, by the "law of demand”. For example, if the price of a product increases by 5% and quantity demanded decreases by 5%, therefore: PED = −5%

PED = −1
The PED is negative for the vast majority of goods and services, however, economists often refer to price elasticity of demand as a positive value (i.e., in absolute value terms). Here is a graph, showing all the possible outcomes of PED according to elastic, inelastic, perfectly elastic, perfectly inelastic and unitary.

As the difference between the two prices or quantities increases, the accuracy of the PED given by the formula decreases for a combination of two reasons. First, the PED for a product is not necessarily always constant. PED can vary at different points along the demand curve, due to its percentage nature. Elasticity is not the same thing as the slope of the demand curve, which is dependent on the units used for both price and quantity. Second, percentage changes are not symmetric, more like the percentage change between any two values depends on which one is chosen as the starting value and which as the ending value. For example, if quantity demanded...
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