CH10 Income and cross elasticities

Question 1

What does income elasticity of demand measure?

Answer 1

it measures the proportionate response of quantity demanded to a proportionate change in income

Question 2

An increase in income will lead to what?

Answer 2

it will lead to an increase in demand for normal goods but a fall in demand for inferior goods

Question 3

What is the formula for measuring income elasticity of demand?

Answer 3

% change in quantity demanded / % change in income

Question 4

when is demand income inelastic?

Answer 4

demand is income inelastic if it lies between +1 and -1

Question 5

when is demand income elastic?

Answer 5

demand is income elastic if it is greater than +1 or less than -1

Question 6

Why does demand fall for inferior goods when income increases?

Answer 6

this is because consumers will react to an increase in their income by purchasing products which are perceived to be of better quality

Question 7

give some examples of commonly quoted inferior goods

Answer 7

bread, margarine, bus transport

Question 8

can a good be both normal and inferior?

Answer 8

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

Question 9

why is the demand curve for a normal good upwards sloping?

Answer 9

because demand increases as income increases

Question 10

Will a normal good have a positive or a negative income elasticity? and why?

Answer 10

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)

Question 11

will an inferior good have a positive or a negative income elasticity? and why?

Answer 11

an inferior good will always have a negative elasticity because the signs on the top and bottom of the formula will always be opposite

Question 12

what do some economists state about necessities and luxuries? and what is the problem with this distinction?

Answer 12

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?

Question 13

what does cross elasticity of demand measure?

Answer 13

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

Question 14

what is the formula for measuring cross elasticity of demand for good x with respect to the price of good y?

Answer 14

% change in quantity demanded of good x / % change in price of good y

Question 15

when is cross elasticity of demand elastic?

Answer 15

if cross elasticity of demand is greater than +1 or less than -1, then it is elastic

Question 16

when is cross elasticity of demand inelastic?

Answer 16

if cross elasticity of demand lies between +1 and -1 then it is inelastic

Question 17

what is a substitute?

Answer 17

it is a good which can be replaced by another good

Question 18

what are examples of substitutes for British consumers?

Answer 18

• Coca-Cola and Pepsi-Cola
• a holiday in Spain and a holiday in Turkey
• an Indian takeaway and a Chinese takeaway

Question 19

will two goods which are substitutes have a positive or negative cross elasticity?

Answer 19

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

Question 20

what is a complement?

Answer 20

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

Question 21

will two goods which are complements have a negative or positive cross elasticity?

Answer 21

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.

Question 22

what would be the cross elasticity of demand for two goods which have little relationship to each other, like cement and chocolate?

Answer 22

their cross elasticity would be zero