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Elasticity of Demand Overview

Oct 28, 2025

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Overview

This lecture covers the main concepts of elasticity of demand, including price elasticity (PED), income elasticity (YED), and cross elasticity (XED), their formulas, types, determinants, and applications in economic analysis.

Price Elasticity of Demand (PED)

  • PED measures the responsiveness of quantity demanded to a change in price, holding other factors constant.
  • Formula: PED = (% change in quantity demanded) / (% change in price).
  • PED values are usually negative due to the inverse relationship between price and quantity demanded, but absolute values are used for simplicity.
  • Use PED when there is a change in supply to evaluate the proportional change in quantity demanded.
  • Types of PED:
    • Price elastic demand: |PED| > 1; change in price leads to a more than proportionate change in quantity demanded.
    • Price inelastic demand: 0 < |PED| < 1; change in price leads to a less than proportionate change in quantity demanded.
  • Main determinants: number and closeness of substitutes, definition of the good, nature/necessity of the good, and proportion of income spent on the good.

Income Elasticity of Demand (YED)

  • YED measures the responsiveness of quantity demanded to a change in consumer income.
  • Formula: YED = (% change in quantity demanded) / (% change in income).
  • YED can be positive (normal goods) or negative (inferior goods).
  • Types of YED for normal goods:
    • Income elastic: YED > 1 (luxury goods; more than proportionate increase in demand as income rises).
    • Income inelastic: 0 < YED < 1 (necessities; less than proportionate increase in demand as income rises).
  • Determinants: degree of necessity of the good, consumer income level, perception of goods (luxury or necessity can change based on income).

Cross Elasticity of Demand (XED)

  • XED measures the responsiveness of quantity demanded for one good to a change in the price of another good.
  • Formula: XED = (% change in quantity demanded of good A) / (% change in price of good B).
  • XED can be positive (substitutes) or negative (complements).
    • Positive XED: increase in price of one good increases demand for the substitute.
    • Negative XED: increase in price of one good decreases demand for the complement.
  • The magnitude of XED shows the closeness of the relationship (higher absolute value = stronger substitute or complement).

Key Terms & Definitions

  • Price Elasticity of Demand (PED) — Responsiveness of quantity demanded to a change in price.
  • Income Elasticity of Demand (YED) — Responsiveness of quantity demanded to a change in income.
  • Cross Elasticity of Demand (XED) — Responsiveness of quantity demanded for one good to a change in price of another good.
  • Elastic Demand — When the absolute value of elasticity > 1.
  • Inelastic Demand — When the absolute value of elasticity < 1.
  • Normal Good — A good with positive YED; demand rises as income increases.
  • Inferior Good — A good with negative YED; demand falls as income increases.
  • Substitute Goods — Goods with positive XED.
  • Complement Goods — Goods with negative XED.

Action Items / Next Steps

  • Review and memorize key definitions and formulas for PED, YED, and XED.
  • Practice calculating elasticity values and identifying determinants.
  • Prepare examples for essays and link elasticity concepts to demand and supply analysis.
  • Stay tuned for the next lecture on supply and essay skills.

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