Income Elasticity and Cross Elasticity of demand (Pack 6)

• How is income elasticity of demand calculated?

  • Income elasticity of demand (YED) = % change in quantity demanded / % change in income
• What is the difference between normal and inferior goods?

  Normal goods increase in demand as income rises
• Give two examples of normal necessities and explain the YED figure you would expect.

  Examples:

  1. Bread
  2. Basic clothing

  • YED figure: Between 0 and 1 (inelastic)
• Give two examples of normal luxuries and explain the YED figure you would expect.

  Examples:

  1. Designer handbags
  2. High-end electronics

  • YED figure: Greater than 1 (elastic)
• Give two examples of inferior goods and explain the YED figure you would expect.

  Examples:

  1. Instant noodles
  2. Second-hand clothes

  • YED figure: Less than 0 (negative)
• Why is it useful to sell a mixture of normal, luxury, and inferior goods?

  It provides different revenue streams and reduces loss of revenue in recessions when supply and demand for the goods will change drastically
• How is cross elasticity of demand calculated?

  • Cross elasticity of demand (XED) = % change in quantity demanded of good A / % change in price of good B
• What type of XED figure would you expect for goods that are substitutes?

  Positive XED figure indicating as the price of one good increases, the demand for another good increases.
• What type of XED figure would you expect for goods that are complements?

  Negative XED figure indicating as price of one good increases, the demand of another falls decreases.
• Explain two goods which are strong complements and two goods which are weak complements.

  Strong complements:

  1. Coffee and sugar
  2. Printers and ink cartridges

  • An XED figure above 1 (when the sign is ignored) indicates a strong relationship

  
  

  Weak complements:

  1. Bread and butter
  2. Cars and gasoline

  • An XED figure below 1 (when the sign is ignored) incidates a strong relationship
• Explain two goods which are strong substitutes and two goods which are weak substitutes.

  Strong substitutes:

  1. Coca-Cola and Pepsi
  2. Butter and margarine

  • An XED figure above 1 (when the sign is ignored) indicates a strong relationship

  
  

  Weak substitutes:

  1. Tea and coffee
  2. Apples and oranges

  • An XED figure below 1 (when the sign is ignored) incidates a strong relationship
• What is Income Elasticity of Demand (YED)?

  The responsiveness of quantity demanded for a good to a change in a consumers income.
• What is Cross Elasticity of Demand (XED)?

  The responsiveness of quantity demanded of a good or service (Good A) to a change in the price of another good or service (Good B).
• Explain the XED figure of 2 Unrelated goods

  Examples:

  1. Cheese
  2. Skateboard

  • An XED figure of 0; For a change in the price of one good, there’ll be no change in quantity demanded for another good or service
• What are Complementary goods?

  • Goods that if the price of one increases, the demand of the other good will decrease
  • They have joint demand
• What are Substitute goods?

  • Goods that if the price of one good increases, the demand of another good will increase
  • They have competitive demand