FormulasFoundationfoundation_paper_4_business_economicsChapter 2
Back to Chapters

Chapter 2

Topics and formulas

Filter by Topic

All Formulas

16 formulas

Price Elasticity of Demand (PED)

Topic: Business CyclesChapter: Chapter 2
PED=%Change in Quantity Demanded%Change in PricePED = \frac{\% \text{Change in Quantity Demanded}}{\% \text{Change in Price}}
This formula measures the responsiveness of the quantity demanded of a good to a change in its price. During a recession, understanding PED helps businesses predict how much sales will fall if they maintain prices, or how much they need to cut prices to stimulate demand. For goods with inelastic demand (e.g., necessities), sales might be relatively stable even during downturns, whereas elastic goods (e.g., luxuries) experience significant drops.

Income Elasticity of Demand (YED)

Topic: Business CyclesChapter: Chapter 2
YED=%Change in Quantity Demanded%Change in IncomeYED = \frac{\% \text{Change in Quantity Demanded}}{\% \text{Change in Income}}
YED measures how sensitive the quantity demanded of a good is to a change in consumers' income. This is highly relevant to business cycles. During economic expansions (booms), incomes rise, leading to increased demand for normal goods (especially luxuries, which have high positive YED). During recessions, incomes fall, causing demand for normal goods to decrease and potentially increasing demand for inferior goods (which have negative YED).

Cross-Price Elasticity of Demand (CPED)

Topic: Business CyclesChapter: Chapter 2
CPED=%Change in Quantity Demanded of Good X%Change in Price of Good YCPED = \frac{\% \text{Change in Quantity Demanded of Good X}}{\% \text{Change in Price of Good Y}}
CPED measures the responsiveness of the quantity demanded of one good (X) to a change in the price of another good (Y). This helps identify substitutes (positive CPED) and complements (negative CPED). During business cycles, as prices of certain goods change due to demand/supply shifts, understanding CPED helps predict how demand for related goods will be affected, impacting strategic decisions for businesses.

Price Elasticity of Supply (PES)

Topic: Business CyclesChapter: Chapter 2
PES=%Change in Quantity Supplied%Change in PricePES = \frac{\% \text{Change in Quantity Supplied}}{\% \text{Change in Price}}
PES measures the responsiveness of the quantity supplied of a good to a change in its price. During a boom, if demand increases rapidly, a high PES indicates that producers can quickly increase output to meet demand, potentially preventing sharp price increases. Conversely, a low PES means supply is slow to react, which could lead to significant price volatility or shortages during booms and oversupply during recessions.

General Demand Function

Topic: Demand AnalysisChapter: Chapter 2
Qd=f(Px,Pr,Y,T,E,O)Q_d = f(P_x, P_r, Y, T, E, O)
This function expresses the quantity demanded (Q_d) of a commodity (x) as a function of its own price (P_x), prices of related goods (P_r), consumer's income (Y), consumer's tastes and preferences (T), consumer's expectations (E), and other factors (O). It indicates that demand is influenced by multiple variables.

Price Elasticity of Demand (Point Method)

Topic: Demand AnalysisChapter: Chapter 2
Ep=%Change in Quantity Demanded%Change in Price=ΔQd/QdΔP/P=ΔQdΔP×PQdE_p = \frac{\% \text{Change in Quantity Demanded}}{\% \text{Change in Price}} = \frac{\Delta Q_d / Q_d}{\Delta P / P} = \frac{\Delta Q_d}{\Delta P} \times \frac{P}{Q_d}
This formula measures the responsiveness of quantity demanded to a small change in the price of the good at a specific point on the demand curve. A higher absolute value indicates greater elasticity, meaning demand is more sensitive to price changes. It is typically negative, but often the absolute value is considered.

Price Elasticity of Demand (Arc Method)

Topic: Demand AnalysisChapter: Chapter 2
Ep=ΔQdΔP×(P1+P2)/2(Q1+Q2)/2=Q2−Q1P2−P1×P1+P2Q1+Q2E_p = \frac{\Delta Q_d}{\Delta P} \times \frac{(P_1 + P_2) / 2}{(Q_1 + Q_2) / 2} = \frac{Q_2 - Q_1}{P_2 - P_1} \times \frac{P_1 + P_2}{Q_1 + Q_2}
Used when there is a significant change in price and quantity, or when calculating elasticity between two distinct points on the demand curve. It provides an average elasticity over a range, using the average of the initial and final prices and quantities to avoid different elasticity values depending on the starting point.

Income Elasticity of Demand

Topic: Demand AnalysisChapter: Chapter 2
Ey=%Change in Quantity Demanded%Change in Income=ΔQd/QdΔY/Y=ΔQdΔY×YQdE_y = \frac{\% \text{Change in Quantity Demanded}}{\% \text{Change in Income}} = \frac{\Delta Q_d / Q_d}{\Delta Y / Y} = \frac{\Delta Q_d}{\Delta Y} \times \frac{Y}{Q_d}
This measures the responsiveness of quantity demanded to a change in consumer income. A positive value indicates a normal good (demand increases with income), while a negative value indicates an inferior good (demand decreases with income). Values greater than 1 typically denote luxury goods, and between 0 and 1 necessities.

Cross Price Elasticity of Demand

Topic: Demand AnalysisChapter: Chapter 2
Exy=%Change in Quantity Demanded of good X%Change in Price of good Y=ΔQx/QxΔPy/Py=ΔQxΔPy×PyQxE_{xy} = \frac{\% \text{Change in Quantity Demanded of good X}}{\% \text{Change in Price of good Y}} = \frac{\Delta Q_x / Q_x}{\Delta P_y / P_y} = \frac{\Delta Q_x}{\Delta P_y} \times \frac{P_y}{Q_x}
This measures the responsiveness of the quantity demanded of one good (X) to a change in the price of another good (Y). A positive value indicates substitute goods (e.g., tea and coffee), while a negative value indicates complementary goods (e.g., cars and petrol). A value of zero suggests unrelated goods.

Advertising Elasticity of Demand

Topic: Demand AnalysisChapter: Chapter 2
EA=%Change in Quantity Demanded%Change in Advertising Expenditure=ΔQd/QdΔA/A=ΔQdΔA×AQdE_A = \frac{\% \text{Change in Quantity Demanded}}{\% \text{Change in Advertising Expenditure}} = \frac{\Delta Q_d / Q_d}{\Delta A / A} = \frac{\Delta Q_d}{\Delta A} \times \frac{A}{Q_d}
This formula quantifies how much the quantity demanded for a product changes in response to a change in advertising expenditure. A positive value indicates that advertising is effective in increasing demand. Businesses use this to optimize their marketing budgets and strategies.

Linear Demand Function

Topic: Demand AnalysisChapter: Chapter 2
Qd=a−bPQ_d = a - bP
A simplified linear representation of the demand function, assuming all other factors are constant. QdQ_d is the quantity demanded, PP is the price of the good, aa is the intercept (quantity demanded when price is zero), and bb is the slope coefficient (change in quantity demanded for a unit change in price).

Price Elasticity of Demand (Percentage Method)

Topic: Demand AnalysisChapter: Chapter 2
Ep=%ΔQd%ΔP=ΔQdQdΔPPE_p = \frac{\% \Delta Q_d}{\% \Delta P} = \frac{\frac{\Delta Q_d}{Q_d}}{\frac{\Delta P}{P}}
Measures the responsiveness of the quantity demanded (QdQ_d) to a percentage change in the price (PP) of the good. ΔQd\Delta Q_d is the change in quantity demanded, ΔP\Delta P is the change in price.

Income Elasticity of Demand (Percentage Method)

Topic: Demand AnalysisChapter: Chapter 2
Ey=%ΔQd%ΔY=ΔQdQdΔYYE_y = \frac{\% \Delta Q_d}{\% \Delta Y} = \frac{\frac{\Delta Q_d}{Q_d}}{\frac{\Delta Y}{Y}}
Measures the responsiveness of the quantity demanded (QdQ_d) to a percentage change in consumer income (YY). ΔQd\Delta Q_d is the change in quantity demanded, ΔY\Delta Y is the change in income.

Income Elasticity of Demand (Arc Method)

Topic: Demand AnalysisChapter: Chapter 2
Ey=(Q2−Q1)/((Q1+Q2)/2)(Y2−Y1)/((Y1+Y2)/2)E_y = \frac{(Q_2 - Q_1) / ((Q_1 + Q_2)/2)}{(Y_2 - Y_1) / ((Y_1 + Y_2)/2)}
Calculates income elasticity over a range of income levels, using average quantities and incomes. Q1,Y1Q_1, Y_1 are initial quantity and income, and Q2,Y2Q_2, Y_2 are new quantity and income.

Cross Elasticity of Demand (Percentage Method)

Topic: Demand AnalysisChapter: Chapter 2
Exy=%ΔQx%ΔPy=ΔQxQxΔPyPyE_{xy} = \frac{\% \Delta Q_x}{\% \Delta P_y} = \frac{\frac{\Delta Q_x}{Q_x}}{\frac{\Delta P_y}{P_y}}
Measures the responsiveness of the quantity demanded of good X (QxQ_x) to a percentage change in the price of a related good Y (PyP_y). ΔQx\Delta Q_x is the change in quantity demanded of X, ΔPy\Delta P_y is the change in price of Y.

Cross Elasticity of Demand (Arc Method)

Topic: Demand AnalysisChapter: Chapter 2
Exy=(Qx2−Qx1)/((Qx1+Qx2)/2)(Py2−Py1)/((Py1+Py2)/2)E_{xy} = \frac{(Q_{x2} - Q_{x1}) / ((Q_{x1} + Q_{x2})/2)}{(P_{y2} - P_{y1}) / ((P_{y1} + P_{y2})/2)}
Calculates cross elasticity over a range of prices for good Y, using average quantities of X and prices of Y. Qx1,Py1Q_{x1}, P_{y1} are initial quantity of X and price of Y, and Qx2,Py2Q_{x2}, P_{y2} are new quantity of X and price of Y.
Chapter 2 Formulas — CA Foundation | Kartavvya