Micro 6 - Income Elasticity of Demand and Cross Elasticity of Demand Flashcards
Define Income Elasticity of Demand
Income Elasticity of Demand measures how much the demand for a good changes with a change in real income
What is the abbreviation for Income Elasticity of Demand?
YED
What is the formula for calculating Income Elasticity of Demand?
Percentage change in quantity demanded of a good / Percentage change in real income
Is YED a percentage?
No
What are the 3 different categories that YED can be?
- Elastic
- Inelastic
- Perfectly inelastic
What does the YED value have to be for a product to have income elastic demand?
Greater than 1
What does a YED value of greater than 1 mean for a product?
It has income elastic demand
What does the YED value have to be for a product to have income inelastic demand?
Less than 1
What does a YED value of less than 1 mean for a product?
It has income inelastic demand
What does the YED value have to be for a product to have perfectly income inelastic demand?
0
What does a YED value of 0 mean for a product?
It has perfectly income inelastic demand
What does a YED value of 5.4 mean?
For every 1% increase in incomes, demand increases by 5.4%
What does it mean for a product to have perfectly income inelastic demand?
No matter how high incomes rise, demand remains constant
Define Cross Elasticity of Demand
Cross Elasticity of Demand is a measure of how the quantity demanded of one good responds to a change in the price of another good
What abbreviation is used to describe Cross Elasticity of Demand?
XED
What is the formula for calculating Cross Elasticity of Demand?
Percentage change in quantity demanded of good A / Percentage change in price of good B
If two goods are substitutes will their XED be positive or negative?
Positive
If two goods are complementary will their XED be positive or negative?
Negative
Do Normal goods have a positive or negative YED sign?
Positive
What type of good will a normal good be with a YED figure between 0 and 1?
A Necessity
What effect does rising incomes have on the demand for normal goods?
It causes demand to increase
What type of good will a normal good be with a YED figure of greater than 1?
A Luxury good
Define a Necessity good in terms of YED
A Necessity good is a good for which the income elasticity of demand is positive and between 0 and 1
Define a luxury good in terms of YED
A good for which the income elasticity of demand is positive and greater than 1
What are normal goods?
Normal goods are those which people will demand more of if their real income increases.
What are inferior goods?
Inferior goods are those which people demand less of if their real income increases.
Do inferior goods have a positive or negative YED sign?
Negative
What will the YED figure be for an inferior good?
Less than 0
Define inferior goods in terms of YED
Inferior goods have a YED figure which is negative and less than 0
What effect will a rise in income have on an inferior good?
A rise in income will lead to the inferior good being replaced with one considered to be of higher quality
Do substitute goods have positive or negative XEDS
Positive
Explain substitute goods in terms of XED
A fall in the price of one substitute will reduce the demand for another. The closer the substitutes, the higher the positive XED
What XED figure indicates a strong relationship between two products?
An XED figure greater than 1
What XED figure indicates a weak relationship between two products?
An XED figure of less than 1
Will complementary goods have a positive or negative XED sign?
Negative
Explain complementary goods in terms of XED
An increase in the price of a good will lead to a reduction in demand for its complements
What does it mean if a good has an XED of 0?
Goods which have an XED of 0 are independent or unrelated and don’t directly affect the demand of each other
How can information about YED be used by firms and governments?
- Sales forecasting
- Pricing Policy
- Supplying a range of goods with various YEDs
How can information about YED be used in sales forecasting?
If the YED of a product and likely changes in income are known then sales levels can be predicted
How can information about YED be used in pricing policy?
A reduction in price for a normal good when there is an expected fall in incomes may limit the expected reduction in demand for the good
Why might a firm choose to supply a range of goods with various YEDs?
During a boom demand for a product with a high YED will increase but demand for that product will decrease when the economy is in a recession. So a firm may also supply products with a low YED so that they can still earn revenue during a recession
How might firms and governments use knowledge of XEDs for their goods?
It’s useful for firms to know the XEDs of their goods because that will tell them how to react to changes in the price of related products to ensure they maximise demand for their products
