Economics IGCSE Edexcel- Price and income elasticity

Price elasticity of demand: The extent to which a change in price will affect demand.

If a product is said to be price elastic for demand, then a change in price will cause a more than proportional/significant change in demand.

If a product is said to be price inelastic for demand, then a change in price will cause a less than proportional/insignificant change in demand.

The equation for price elasticity of demand is:

Price elasticity of demand= percentage change in quantity demanded / percentage change in price

If the value is between -1 and 0 then it is price inelastic for demand while if it is smaller than -1 it is price elastic for demand.

Factors affecting the price elasticity of demand:

1. The availability of substitutes- the greater the number of products to replace the certain products, then the more price elastic as consumers are more able to switch to other products.
2. Degree of necessity- essential products are generally inelastic.
3. Proportion of income spent- generally, the higher the proportion of income the more elastic the product while those that only take up a small proportion of income are inelastic.

A steep demand curve is more inelastic than a gentle one. It is almost impossible to have perfectly elastic or inelastic products.

Price elasticity of supply: The extent to which a change in price will affect supply.

If a product is said to be price elastic for supply, then a change in price will cause a more than proportional/significant change in supply.

If a product is said to be price inelastic for supply, then a change in price will cause a less than proportional/insignificant change in supply.

The equation for price elasticity of supply is:

Price elasticity of supply= percentage change in quantity supplied / percentage change in price

If the value is between 0 and 1 then it is price inelastic for supply while if it is larger than 1 it is price elastic for supply.

Factors affecting the price elasticity of supply:

1. Stock levels- if a producer can hold stocks of goods they can respond quickly to a change in price so the good will be more price elastic for supply.
2. Production speed- the faster the producer can produce the good the more price elastic for supply.
3. Spare capacity- if the producer have the ability to produce more with their resource then the good will be more price elastic for supply.
4. Ease of entry into the market- if it is difficult for new firms to join a market then supply will be price inelastic.

The steeper the supply curve, the more price inelastic for supply.

Income elasticity of demand: the extent to which a change in income will affect demand.

The equation for income elasticity of demand is:

Income elasticity of demand= percentage change in quantity demanded / percentage change in income

If the value is greater than 1, or less than -1 it is income elastic while if it is between 1 and -1 it is inelastic.

normal good = >0

necessity = 0-1

luxury good = >1

inferior good = <0

Factors affecting the income elasticity of demand:

1. Necessities are income inelastic
2. Luxury goods are income elastic

Note: there is no need to know about income elasticity of supply as it is not on the syllabus.

Application of elasticity:

1. Firms will raise prices for inelastic products and will decrease or keep the same price for elastic product to increase total revenue.
2. Government target inelastic products to impose taxes and VAT as they know demand won't be drastically changed.