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Income Elasticity of Demand
The income elasticity of demand is defined asthe percentage change in quantity divided bythe percentage change in income,all other influences remaining constant
Income elasticity of demand εI %ΔQ D
%ΔI
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Price and Income Elasticities of Demand
Income elasticity measures shifts in the demand curve
Price elasticity measures movements along the curve
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Demand for Q
68
101214161820222426283032
20 30 40 50 60 70 80 90 100 110 120
Quantity
Pri
ce
D1, I = 3000
Graphical Analysis
D2, I = 4000
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Price Income Demand13.00 3000.00 68.7514.00 3000.00 63.7420.00 3000.00 44.2021.00 3000.00 42.03
Computing price elasticity (income constant)
13.00 4000.00 91.8314.00 4000.00 85.1720.00 4000.00 59.2021.00 4000.00 56.31
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(Q1 Q0)
(P1 P0)
(P1 P0)
(Q1 Q0)
εD %ΔQ D
%ΔP
Price Elasticity of Demand (Income = 4000)Price Income Demand20.00 4000.00 59.2021.00 4000.00 56.31
(56.31 59.20)(21 20)
(21 20)(56.31 59.20)
( 2.89)(1)
(41)(115.51)
1.0257
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(Q1 Q0)
(P1 P0)
(P1 P0)
(Q1 Q0)
εD %ΔQ D
%ΔP
Price Elasticity of Demand (Income = 3000)Price Income Demand20.00 3000.00 44.2021.00 3000.00 42.03
(44.20 42.03)(21 20)
(21 20)(44.20 42.03 )
( 2.17)(1)
(41)(86.23)
1.03177 -1.0257
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Price Income Demand13.00 3000.00 68.7514.00 3000.00 63.7420.00 3000.00 44.2021.00 3000.00 42.0313.00 4000.00 91.8314.00 4000.00 85.1720.00 4000.00 59.2021.00 4000.00 56.31
Computing income elasticity (price constant)
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Price Income Demand13.00 3000.00 68.7514.00 3000.00 63.7420.00 3000.00 44.2021.00 3000.00 42.0313.00 4000.00 91.8314.00 4000.00 85.1720.00 4000.00 59.2021.00 4000.00 56.31
Q
Computing income elasticity (price constant)
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Demand Data on Q
Price Income Demand13.00 3000.00 68.7514.00 3000.00 63.7420.00 3000.00 44.2021.00 3000.00 42.0313.00 4000.00 91.8314.00 4000.00 85.1720.00 4000.00 59.2021.00 4000.00 56.31
Q I
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εI %ΔQ D
%ΔI
Income Elasticity of Demand
PriceIncome Demand20.00 3000.00 44.2020.00 4000.00 59.20
(Q1 Q0)
(I1 I0)
(I1 I0)
(Q1 Q0)
(44.2 59.20)(3,000 4,000)
(3,000 4,000)(44.2 59.20)
( 15)( 1000)
(7,000)(103.4)
1.01547
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Normal and Inferior Goods
Normal goods have a positive income elasticity
Inferior goods have a negative income elasticity
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Necessities and Luxuries
Necessities typically have an income elasticitybetween 0 and 1
Luxuries typically have an income elasticitygreater than 1
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Examples
Fresh Fruit
Transportation (???)
Potatoes
Eating out
Cigarettes
Food
Meat (Steak)
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Cross-price Elasticity of Demand
The cross price elasticity of demand is defined asthe percentage change in the
quantity demanded of one good,
all other influences remaining constant
divided by the percentage change in theprice of a different good,
We denote the cross price elasticity of good i for good jas ij where
εij %ΔQ D
i
%ΔPjvideo.edhole.com
We can then rewrite this as
(Q 1
i Q 0i )
(P 1j P 0
j )
(P 1j P 0
j )
(Q 1i Q 0
i )
εij %ΔQ D
i
%ΔPj
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Elasticities of Demand
Income elasticity measures shifts in the demand curve
Price elasticity measures movements along the curve
Cross-price elasticity measures shifts in the demand curve
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Demand for Q1
8101214161820222426283032
20 30 40 50 60 70 80 90 100
Quantity
Pri
ce D1, P2 = 10
D1, P2 = 50
Graphical Analysis
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Demand Data for Alternative Prices of Good 2
P1 P2 Income D113.00 10.00 3,000 68.7514.00 10.00 3,000 63.74
13.00 50.00 3,000 72.45
20.00 10.00 3,000 44.2021.00 10.00 3,000 42.03
14.00 50.00 3,000 67.1720.00 50.00 3,000 46.6021.00 50.00 3,000 44.3122.00 50.00 3,000 42.24
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Demand Data for Alternative Prices of Good 2
P1 P2 Income D113.00 10.00 3,000 68.7514.00 10.00 3,000 63.74
13.00 50.00 3,000 72.45
20.00 10.00 3,000 44.2021.00 10.00 3,000 42.03
14.00 50.00 3,000 67.1720.00 50.00 3,000 46.6021.00 50.00 3,000 44.3122.00 50.00 3,000 42.24
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εD %ΔQ D
%ΔP
Price Elasticity of DemandPrice Income Demand20.00 3000.00 44.2021.00 3000.00 42.03
(Q1 Q0)
(P1 P0)
(P1 P0)
(Q1 Q0 )
(44.20 42.03)(20 21)
(20 21)(44.2 42.03)
(2.17)( 1)
(41)(86.23)
1.03177video.edhole.com
Cross-price elasticity of demand for good 1as the price of good 2 changes from $10 to $50
εij %ΔQ D
1
%ΔP2
P1 P2 Income D120.00 10.00 3,000 44.2020.00 50.00 3,000 46.60
(Q 1
1 Q 01 )
(P 12 P 0
2 )
(P 12 P 0
2 )
(Q 11 Q 0
1 )
(44.2 46.60)(10 50)
(10 50)(44.2 46.60)
( 2.4)( 40)
(60)(90.80)
.0396
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Substitutes and Complements
Goods are said to be substitutes if ij > 0
Goods are said to be complements if ij < 0
Goods are said to be close substitutes if ij >> 0
Demand goes up as other price goes up
Demand goes down as other price goes up
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Substitutes
Beef and Pork
Rice Chex and Life Cereal
Ford and Dodge Cars
Margarine and Butter
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Complements
Food and Entertainment
Cars and Gasoline
Printers and Printer Paper
Televisions and VCRs
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The elasticity of supply is defined asthe percentage change in quantity supplieddivided by the percentage change in price,
Elasticity of Supply
all other influences remaining constant
εs %ΔQ S
%ΔP
(Q S
1 Q S0 )
(P1 P0)
(P1 P0 )
(Q S1 Q S
0 )video.edhole.com
The elasticity of supplymeasures movements along the supply curve
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Graphical Analysis
Supply of Shirts
0255075
100125150175200225250275300325350375400
0 10 20 30 40 50 60 70 80 90 100
Quantity
Pri
ce
Q P0 05 2010 4015 6020 8025 10030 12035 14040 16045 18050 20055 22060 240
Supply Data
εs %ΔQ S
%ΔP
(Q S
1 Q S0 )
(P1 P0)
(P1 P0)
(Q S1 Q S
0 )
(25 20)(100 80)
(100 80)(25 20)
(5)(20)
(180)(45)
14
4 1video.edhole.com
14
4 1
Another Example of Elasticity of Supply
Q P50 20055 220
εs %ΔQ S
%ΔP
(Q S
1 Q S0 )
(P1 P0)
(P1 P0)
(Q S1 Q S
0 )
(50 55)(200 220)
(200 220)(50 55)
(5)(20)
(420)(105)
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Factors affecting the elasticity of supply
Supply will be more elastic, the more alternatives producers of it have for production.
Supply will be more elastic if the marketis defined narrowly.
Supply will be much more elastic in the long run.
Supply will be more inelastic if there are biological or other lags in production
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Classification of the elasticity of supply
Inelastic supply
When the numerical value of the elasticity of supply is between 0 and 1.0, we say that supply is inelastic.
%ΔQ S
%ΔP< 1
%ΔQ S < %ΔP
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Elastic supply
When the numerical value of the elasticity of supply
is greater than 1.0, we say that supply is elastic.
%ΔQ S
%ΔP> 1
%ΔQ S > %ΔP
Classification of the elasticity of supply
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Unitary elastic supply
When the numerical value of the elasticity of supply is equal to 1.0, we say that supply is unitary elastic.
%ΔQ S
%ΔP 1
%ΔQ S %ΔP
Classification of the elasticity of supply
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Classification of the elasticity of supply
Perfectly elastic - S =
Perfectly inelastic - S = 0
horizontalhorizontal
verticalvertical
Very short run responseVery short run response
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Demand for food and food products is generally price inelastic
Supply of many crops is stochastic due to weather, disease, etc
Thus we tend to see large changes in price and thus net farm income
Analysis of an agricultural market
%ΔQ D
%ΔP< 1
%ΔP
%ΔQ D> 1
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End of PresentationEnd of Presentation
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