Income & Cross Elasticities Of Demand

What does Income Elasticity of Demand (YED) measure?

The responsiveness of quantity demanded to a change in consumer income.

Why are economists interested in Income Elasticity of Demand?

Because it shows how demand for different goods changes as incomes rise or fall, helping classify goods as normal, luxury, or inferior.

What is the formula for Income Elasticity of Demand?

YED= %ΔQD​ / %ΔIncome

What does a positive YED value mean?

The good is a normal good.

What does a negative YED value mean?

The good is an inferior good.

What YED values represent normal necessity goods?

0 < YED < 1

What happens to demand for necessity goods when income rises?

Demand increases, but less than proportionally.

Why are necessities income inelastic?

Because consumers cannot greatly increase consumption, even if income rises.

What YED values represent luxury goods?

YED > 1

What happens to demand for luxury goods when income increases?

Demand increases more than proportionally.

Why are luxury goods income elastic?

Because consumers buy significantly more when their incomes rise.

What YED values represent inferior goods?

YED<0

What happens to demand for inferior goods when income increases?

Demand decreases.

Why does demand for inferior goods fall when income rises?

Consumers switch to higher-quality substitutes.

What type of good is identified if YED is positive?

A normal good.

What type of good is identified if YED is negative?

An inferior good.

What does the size of the YED value tell us?

How responsive demand is to income changes.

What does Cross Elasticity of Demand measure?

The responsiveness of demand for one good when the price of another good changes.

Why does a change in the price of one good affect another good?

Because goods may be substitutes or complements.

What are substitute goods?

Goods that replace each other.

What are complementary goods?

Goods that are used together. E.g cars and petrol

What is the formula for Cross Elasticity of Demand?

XED= %ΔQD of Good A​ / %Δ Price of good B

What XED value indicates complementary goods?

XED<0

Why is XED negative for complementary goods?

Because when the price of one good rises, demand for the other falls.

What XED value indicates substitute goods?

XED>0

Why is XED positive for substitute goods?

Because when the price of one good rises, demand for the other increases.

Give examples of substitute goods.

• Butter and margarine

• Pepsi and Coca-Cola

• Train travel and bus travel

What XED value indicates unrelated goods?

XED = 0

What does an XED value of zero mean?

The goods have no relationship, so a price change in one does not affect demand for the other.

What does the magnitude (size) of the XED value indicate?

How strongly related the goods are.

What does a large positive XED value mean?

The goods are close substitutes.

What does a large negative XED value mean?

The goods are strong complements.

If the price of coffee rises and demand for tea increases, what type of goods are they?

Substitute goods (XED > 0).

If the price of petrol rises and demand for cars falls, what type of goods are they?

Complementary goods (XED < 0).

Why might firms analyse XED with competitors’ products?

To understand how price changes by competitors will affect their demand.