5.3 Responsiveness of Demand to Other Factors

1. Introduction to Alternative Elasticity Measures

• While the response of quantity demanded to changes in price (price elasticity) is widely used, economists also investigate how consumers react to other factors.

• Two key alternative measures of elasticity are:

  • Income Elasticity of Demand

  • Cross-Price Elasticity of Demand

• These measures reflect shifts in the demand curve, unlike price elasticity which reflects movements along a demand curve.

2. Income Elasticity of Demand

• Objective: Explain the concept of income elasticity of demand and show how it is calculated.

• Concept: Income elasticity of demand ($eY$) measures the percentage change in quantity demanded in response to a percentage change in income, holding all other factors (including price) constant.

• Calculation: eY = \frac{\text{% change in quantity demanded}}{\text{% change in income}} = \frac{\% \Delta QD}{\%\Delta Y}

  • The symbol $Y$ often represents income in economics.

• Objective: Classify goods as normal or inferior depending on their income elasticity of demand.

• Classification Criteria:

  • Normal Good: A good for which demand increases as income rises (and decreases as income falls). Its income elasticity of demand is positive (eY > 0).

  • Example (Pizza): If income increases by 10% and pizza consumption increases by 20%: $eY = \frac{+20\%}{+10\%} = +2$

    • This indicates pizza is a normal good; for every 1% increase in income, pizza consumption increases by 2%.

  • Real-world examples of normal goods (positive $eY$): Cellular data, meals outside the home, concert tickets, medical services.

  • Inferior Good: A good for which demand decreases as income rises (and increases as income falls). Its income elasticity of demand is negative (eY < 0).

  • Example (Ramen): If income increases by 10% and ramen consumption decreases by 30%: $eY = \frac{-30\%}{+10\%} = -3$

    • This indicates ramen is an inferior good; for every 1% increase in income, ramen consumption decreases by 3%.

  • Real-world examples of inferior goods (negative $eY$): Used clothing, beans, urban public transit (e.g., France $-0.23$, Spain $-0.25$).

• Note: Economists rely on real-world data and income elasticity calculations to classify goods as normal or inferior, as it's not evident by simply observing a good.

3. Cross-Price Elasticity of Demand

• Objective: Explain the concept of cross-price elasticity of demand and show how it is calculated.

• Concept: Cross-price elasticity of demand ($eA,B$) measures the percentage change in the quantity demanded of one good (Good A) in response to a percentage change in the price of another related good (Good B), holding all other factors constant.

• Calculation:
  eA,B = \frac{\text{% change in quantity of good A demanded}}{\text{% change in price of good B}} = \frac{\% \Delta QA}{\% \Delta PB}

• This elasticity measures the magnitude of a shift in the demand curve for good A due to a price change in good B.

• Objective: Classify goods as substitutes or complements depending on their cross-price elasticity of demand.

• Classification Criteria:

  • Substitutes: Goods that can be consumed in place of one another. An increase in the price of one leads to an increase in the demand for the other. Their cross-price elasticity of demand is positive (eA,B > 0).

  • Examples: Pencils and pens, margarine and butter, Netflix and Hulu.

  • Complements: Goods that are typically consumed together. An increase in the price of one leads to a decrease in the demand for the other. Their cross-price elasticity of demand is negative (eA,B < 0).

  • Examples: Chips and salsa, shampoo and conditioner, pencils and paper.

  • Unrelated Goods: Goods where a change in the price of one does not affect the demand for the other. Their cross-price elasticity of demand is zero ($eA,B = 0$).

  • Examples: Pickles and pencils, batteries and cleaning spray.

• Example (Greeting Cards and Flowers): If the cross-price elasticity of demand for greeting cards with respect to the price of flowers is -0.4$: e{\text{Cards,Flowers}} = \frac{\% \Delta Q{\text{Cards}}}{\% \Delta P_{\text{Flowers}}} = -0.4$</p><ul><li><p>Since the cross-price elasticity is negative, flowers and cards are complements. When the price of flowers goes up ($\Delta P{\text{Flowers}}$is positive), the quantity demanded of cards goes down ($$\Delta Q{\text{Cards}}$is negative).</p></li></ul></li></ul><h5 id="0c1ba558-6fe3-4571-8c97-eda20db5acaa" data-toc-id="0c1ba558-6fe3-4571-8c97-eda20db5acaa" collapsed="false" seolevelmigrated="true">4. Key Differences in Elasticity Measures</h5><ul><li><p><strong>Price Elasticity of Demand:</strong> Concerned with the absolute value ($|>1|$,$|<1|$,$|=1) to understand total revenue implications. Uses terms like "elastic" or "inelastic."

• Income Elasticity of Demand & Cross-Price Elasticity of Demand: Primarily concerned with the sign (positive, negative, or zero) of the calculated value to classify goods (normal/inferior or substitutes/complements).

5. Case Study: Various Demand Elasticities for Conventional and Organic Milk

• Own-Price Elasticity Findings (by Oral Capps and team):

  • Organic Milk: -2.00$(highly elastic) - suggests many perceived substitutes.</p></li><li><p>Conventional Milk:$-0.87$(price inelastic) - suggests fewer perceived substitutes.</p></li><li><p>Soy Milk:$-1.68$(highly elastic)</p></li></ul></li><li><p><strong>Income Elasticity Findings:</strong></p><ul><li><p>Organic Milk:$+0.27$(normal good)</p></li><li><p>Soy Milk:$+0.16$(normal good)</p></li><li><p>Conventional Milk:$-0.01$(inferior good) - indicates that as incomes rise, demand for conventional milk slightly decreases.</p></li></ul></li><li><p><strong>Cross-Price Elasticity Findings (between milk types):</strong></p><ul><li><p>All cross-price elasticities between conventional, organic, and soy milk are <strong>positive</strong>, indicating that consumers regard all these products as substitutes.</p></li><li><p><strong>Asymmetry:</strong> A 1$e{\text{Cream Cheese,Bagels}} = \frac{\% \Delta Q{\text{Cream Cheese}}}{\% \Delta P_{\text{Bagels}}} = \frac{-3\%}{+10\%} = -0.3$</p></li><li><p>Because the cross-price elasticity is negative, bagels and cream cheese are <strong>complements</strong>.</p></li><li><p><strong>Income Elasticity (Bagels):</strong><br>$eY{\text{Bagels}} = \frac{\% \Delta Q{\text{Bagels}}}{\% \Delta Y} = \frac{+1\%}{+10\%} = +0.1$$

  • Because the income elasticity is positive, bagels are a normal good.