Income Elasticity of Demand, Cross Price Elasticity of Demand, Price Elasticity of Supply

I N C O M E E L A S T I C I T Y O F D E M A N D
C R O S S P R I C E E L A S T I C I T Y O F D E M A N D
P R I C E E L A S T I C I T Y O F S U P P L Y
Economics

What is Income Elasticity Demand?
 This measures how the quantity demanded changes
as consumer income changes.
 Income Elasticity of demand is equal to:
 % change in quantity demanded
 % change in income

Income Elasticity Demand
 The income elasticity demand measures the rate of
response of quantity demand due to a raise (or
lowering) in a consumer income.

Income Elasticity of Demand
 If income is low and it still decreases, the demand for
inferior goods therefore increases.

Income Elasticity of Demand FORMULA
% Change in Quantity Demanded
Percentage Change in Income

Example
(QDemand(NEW)-QDemand(OLD)/QDemand(OLD)*100=
%Change in QDemand
{(9-99)}/99 x 100 = -90.91%
(Income(NEW)-Income(OLD)/Income(OLD) X 100 =
%Change in Income
{(1,000,000-2,000)}/2,000 =998,000/2,000 x 100 =49,000%

Example
Income elasticity of demand =
90.91%/49,000 = -0.002
Negative income elasticity = Inferior good

Results of Income Elasticity
Negative = <0
Inferior goods
Positive = >0
Normal goods
Necessary goods = 0
– 1
N0n-essential = >1

Cross Price Elasticity of
Demand

Cross Price Elasticity of Demand
 This measures how quantity demanded changes as
the price of a related good changes.
 Cross price elasticity (Xed) measures responsiveness
of demand for good X following a change in the price
of a related good Y.

 Substitutes:
-Substitutes are products in competitive demand.
-With substitutes, an increase in the price of one good (ceteris
paribus) will lead to an increase in demand for a rival product.
-The value of XED for two substitutes is always positive.

 Complements:
-Complements are products in joint demand.
-A fall in the price of one product causes an increase in demand
for the complementary product.
-The value of Xed for two complements is always negative.

Example:
Changing prices and demand for Dr. Beats
headphones.
Beats Studio headphones retail at approximately £200
per unit.
Following a change in price of the headphones (an
increase in £20), there is an increase demand for a
rival brand of headphones by 5%.
What is the Xed of this price change?
• % change in demand of Y=5%
• % Change in price of X =10%
• Coefficient of PED = +0.5
• The two goods are fairly weak substitute products.

Table shows price and quantity demanded of goods, X and Y.
Price of X Quantity
Demanded of X
Quantity
Demanded of Y
£30 400 250
£15 700 400
Calculate the XED for Y with respect to the price of X.
• % change in price of X = -50%
• % change in demand of Y = +60%
• Xed for good Y = -1.2
• The two goods are fairly close complements.

Understanding the Coefficient of Cross Price Elasticity
 Substitutes:
-Close substitutes have a strongly positive cross price elasticity of
demand i.e. a small change in relative price causes a big switch in
consumer demand.
 Complements
-When there is a strong complementary relationship, the cross
elasticity will be highly negative.
-An example might be the game consoles and software games
 Unrelated products:
-Unrelated products have zero cross elasticity e.g. the effect of changes in
taxi fares on the market demand for cheese.
The stronger the relationship between two products, the higher the co-efficient of
cross-price elasticity of demand.

Price Elasticity Supply
What is PES?
 Supply extends so that consumers get what they
want.
 Price Elasticity of Supply is a measure of the
responsiveness of quantity supplied to a change in
price.

But.. How do you calculate the
price of elasticity of supply?

Calculations of PES
To measure the Price Elasticity Supply, we use the
following formula:
PES = % Change in Quantity
Supplied/ Change in Price

Determinants on PES
1. How much and how readily available any raw
materials, and what alternative suppliers are
available.
2. Production Process- In particular, how much
flexibility is there in the capacity.
3. Length of time of process- i.e before recovery of
expenditure on raw materials.
4. Storage capacity of suppliers and merchants.

Special Supply Curves
 If the quantity supplied of a commodity remains the
same whatever it’s price, supply is said to be
perfectly price inelastic.
That is: PES = 0
 If producers are willing to supply as much as they
can in one particular price and supply nothing at any
other price, then supply is said to be infinitely price
elastic.
That is: PES = ∞

Special Supply Curves
 If PES = 1, the supply is said to be of unitary
elasticity. A percentage change in price will cause an
equivalent percentage change in quantity supplied.
(Straight Line Supply Curve)

Subsidies and Supply
 A subsidy is money provide by the government to
producers or consumers of a specific product.
When the government provides a supply-side subsidy to the
producers of a product, the supply curve shifts to the right and the
demand curve remains the same because they are being subsidized,
producers are encouraged to produce more of a product and are able
to do so for less.

Taxes and Supply
 Taxes reduce both demand and supply, and drive
market equilibrium to a price that is higher than
without the tax and a quantity that is lower than
without the tax.

Taxes and Supply
 If sellers easily can switch to producing other goods,
or if they will respond to even a small reduction in
payments by going out of business, then they will not
accept a much lower price.
The incidence of the tax will tend to fall on the side of the
market that has the least attractive alternatives and,
therefore, has a lower elasticity.

Price Elasticity Supply
CONCLUSION
 Price Elasticity of Supply is a measure of the
responsiveness of quantity supplied to a change in
price.
 It’s formula: % change in quantity
Supplied/% change in price
 Taxes and Subsidies affect it

Income Elasticity of Demand, Cross Price Elasticity of Demand, Price Elasticity of Supply

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