A-Level Economics May/June 2024 Q1(d): Using the concept of price elasticity of demand, assess the relative impact on poorer h…

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  Price elasticity of demand (PED) measures the responsiveness of the quantity demanded of a good to a change in its price. It is calculated as:

  $PED = \frac{\% \Delta \text{Quantity Demanded}}{\% \Delta \text{Price}}$

  Food and energy are necessity goods, meaning they are essential for daily life and have few close substitutes. Consequently, the demand for both food and energy is price inelastic. This means that when their prices rise, the quantity demanded falls by a proportionally smaller amount (the PED value is between 0 and -1). Households cannot easily reduce their consumption of heating, electricity, or basic foodstuffs even when prices increase.

  For poorer households, including those on fixed incomes like pensioners or welfare recipients, the impact of rising prices for these goods is particularly severe. These households already spend a significantly larger proportion of their income on necessities compared to wealthier households. When prices for food and energy rise, and their nominal income does not increase (or increases by less than inflation), their real income falls sharply. They are forced to allocate an even greater share of their budget to these essential items, drastically reducing their discretionary income and potentially forcing them to cut back on other goods and services, leading to a decline in their overall standard of living.

  In contrast, higher-income households are better able to absorb these price increases. Not only do food and energy constitute a smaller fraction of their total expenditure, but they may also have savings to draw upon or greater bargaining power to secure wage increases that keep pace with inflation. Therefore, the relative impact is much less severe for them.

  The extent of the negative impact on poorer households is very significant, but it can be mitigated by government intervention. Policies such as targeted energy subsidies, increased welfare payments, or food stamp programmes can help to cushion the blow and protect real incomes. Without such support, many poorer households would face acute financial hardship, potentially falling into poverty or debt.

  In conclusion, due to the price inelastic demand for food and energy, rising prices have a disproportionately severe and detrimental impact on poorer and fixed-income households. This is because these goods form a large part of their expenditure, and their inability to absorb the price hikes leads to a significant fall in real income and living standards, an outcome that can only be substantially alleviated through targeted government assistance.

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  How the marks are awarded

  • AO1 (1) — The first paragraph provides an accurate definition of PED, explaining it as a measure of responsiveness, and includes the correct formula.
  • AO2 (1) — The second paragraph correctly identifies food and energy as necessities with price inelastic demand, explaining that this means quantity demanded is not very responsive to price changes.
  • AO2 (1) — The third paragraph explains the detrimental effect on poorer and fixed-income households, linking it to the large proportion of income spent on these goods and the resulting fall in real income.
  • AO2 (1) — The fourth paragraph provides a direct comparison to higher-income households, explaining why they are better able to absorb the price rises, thus fulfilling the 'relative impact' aspect of the question.
  • AO3 (1) — The fifth paragraph provides a clear assessment of the extent of the impact, evaluating that it is 'very significant' but can be mitigated by government intervention, which introduces nuance.
  • AO3 (1) — The final paragraph offers a justified conclusion, summarising the key points (inelastic demand, proportion of income) to support the judgement that the impact is 'disproportionately severe'.

  Common mistakes

  • Simply stating that demand is inelastic without explaining why (i.e., because food and energy are necessities with few substitutes).
  • Describing the negative impact on poor households (analysis) but failing to assess the extent of this impact or consider mitigating factors like government support (evaluation).
  • Confusing price inelastic demand with perfectly inelastic demand, incorrectly stating that the quantity demanded will not change at all.
  • Failing to make a relative comparison, i.e., not contrasting the impact on poorer households with the impact on wealthier households.

  Examiner tip: For questions asking for an assessment, always go beyond just explaining the effect and evaluate its significance, considering different groups and potential counter-arguments or mitigating factors.

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