CH10 Income and cross elasticities Flashcards
What does income elasticity of demand measure?
it measures the proportionate response of quantity demanded to a proportionate change in income
An increase in income will lead to what?
it will lead to an increase in demand for normal goods but a fall in demand for inferior goods
What is the formula for measuring income elasticity of demand?
% change in quantity demanded / % change in income
when is demand income inelastic?
demand is income inelastic if it lies between +1 and -1
when is demand income elastic?
demand is income elastic if it is greater than +1 or less than -1
Why does demand fall for inferior goods when income increases?
this is because consumers will react to an increase in their income by purchasing products which are perceived to be of better quality
give some examples of commonly quoted inferior goods
bread, margarine, bus transport
can a good be both normal and inferior?
yes, depending on the level of income
-bread may be a normal good for people on low incomes (i.e. they buy more bread when their income rises). But it may be an inferior good for higher income earners
why is the demand curve for a normal good upwards sloping?
because demand increases as income increases
Will a normal good have a positive or a negative income elasticity? and why?
a normal good will always have a positive income elasticity.
-this is because quantity demanded and income either both increase (giving a plus divided by a plus) or both decrease (giving a minus divided by a minus)
will an inferior good have a positive or a negative income elasticity? and why?
an inferior good will always have a negative elasticity because the signs on the top and bottom of the formula will always be opposite
what do some economists state about necessities and luxuries? and what is the problem with this distinction?
they state that necessities have an income elasticity of less than +1 whilst luxury goods have an income elasticity of greater than +1
-the problem with this distinction is that many products which have an income elasticity of less than +1 would hardly be classified as ‘necessities’ by most consumers. E.g most foods have an income elasticity of less than +1 and would therefore all be classified as necessities. Yet should a fruit juice be just as much a necessity as tea, milk or meat?
what does cross elasticity of demand measure?
cross elasticity of demand measures the proportionate response of quantity demanded of one good to a proportionate change in price of another good
-e.g. it is a measure of the extent to which demand for pork increases when the price of beef goes up
what is the formula for measuring cross elasticity of demand for good x with respect to the price of good y?
% change in quantity demanded of good x / % change in price of good y
when is cross elasticity of demand elastic?
if cross elasticity of demand is greater than +1 or less than -1, then it is elastic
when is cross elasticity of demand inelastic?
if cross elasticity of demand lies between +1 and -1 then it is inelastic
what is a substitute?
it is a good which can be replaced by another good
what are examples of substitutes for British consumers?
- Coca-Cola and Pepsi-Cola
- a holiday in Spain and a holiday in Turkey
- an Indian takeaway and a Chinese takeaway
will two goods which are substitutes have a positive or negative cross elasticity?
two goods which are substitutes will have a positive cross elasticity.
-an increase (positive) in the price of one good such as a holiday in Spain, leads to an increase (positive) in the quantity demanded of a substitute such as a holiday in Turkey
what is a complement?
a good which is demanded because it is used with another good. Examples of complements are:
-tennis rackets and tennis balls
-washing machines and soap powder
-foreign holidays and sun cream
-tablets and apps
will two goods which are complements have a negative or positive cross elasticity?
two goods which are complements will have a negative cross elasticity
-an increase (positive) in the price of one good such as foreign holidays leads to a fall (negative) in demand for a complement such as sun cream.
what would be the cross elasticity of demand for two goods which have little relationship to each other, like cement and chocolate?
their cross elasticity would be zero
