Income elasticity of demand measures the responsiveness of quantity demanded to a change in consumer income.
Types of Goods
| Income Elasticity | Type of Good | Effect of Income Increase |
|---|---|---|
| Ei > 1 | Normal luxury | Quantity demanded increases by a larger percentage |
| 0 < Ei < 1 | Normal necessity | Quantity demanded increases by a smaller percentage |
| Ei < 0 | Inferior good | Quantity demanded decreases |
Normal Goods
Income elasticity is positive.
Normal goods can be divided into:
Necessities: 0 < Ei < 1
Luxuries: Ei > 1
Inferior Goods
Income elasticity is negative.
When consumer income increases, quantity demanded decreases.
Cross Elasticity of Demand
Cross elasticity of demand measures the responsiveness of quantity demanded of one good to a change in the price of another good.
Types of Related Goods
| Cross Elasticity | Relationship |
|---|---|
| Exy > 0 | Substitute goods |
| Exy < 0 | Complementary goods |
| Exy approximately 0 | Independent goods |
Substitute Goods
Substitute goods can be used instead of each other.
Cross elasticity is positive.
Example: Coca-Cola and Pepsi.
If the price of Coca-Cola increases, demand for Pepsi may increase.
Complementary Goods
Complementary goods are normally consumed together.
Cross elasticity is negative.
Example: Mobile phones and mobile phone services.
If the price of mobile phones decreases, demand for mobile phone services may increase.
Independent Goods
Independent goods have little or no relationship in consumption.
Their cross elasticity is approximately zero.
Price Elasticity of Supply
Price elasticity of supply measures the responsiveness of quantity supplied to a change in price.
Categories of Price Elasticity of Supply
| Type | Elasticity | Meaning |
|---|---|---|
| Elastic Supply | Es > 1 | Quantity supplied changes by a larger percentage than price |
| Inelastic Supply | Es < 1 | Quantity supplied changes by a smaller percentage than price |
| Unit Elastic Supply | Es = 1 | Quantity supplied changes by the same percentage as price |
Worked Examples
Income Elasticity Calculation
Income rises from 1,000 to 2,000 and quantity demanded rises from 10 to 20. Find the income elasticity of demand.
Solution Reveal Hide
The good is a normal good with unitary income elasticity.
Identifying Complements
The price of good A falls and the demand for good B rises. Identify the relationship between A and B.
Solution Reveal Hide
The cross elasticity is negative, so A and B are complements.
For example: printers and ink.
Zero Cross Elasticity
What is the relationship between 2 goods with a cross elasticity of zero?
Solution Reveal Hide
A price change in one good does not affect the demand for the other, so the goods are independent and have no relationship.
Substitutes have positive cross elasticity and complements have negative cross elasticity.
Elasticities and a Price Rise
For a good, and . The price rises by 10%. Find the changes in quantity demanded and quantity supplied.
Solution Reveal Hide
Quantity supplied exceeds quantity demanded, so there is a surplus that puts downward pressure on price.
