Cross-Price, Income and Supply Elasticities

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Cross-Price, Income and Supply Elasticities
Overheads
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Income Elasticity of Demand
The income elasticity of demand is defined as the
percentage change in quantity divided by the
percentage change in income,
all other influences remaining constant
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Price and Income Elasticities of Demand
Income elasticity measures shifts in the demand
curve
Price elasticity measures movements along the
curve
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Graphical Analysis
Demand for Q
32
30
Price
28
26
24
22
20
18
16
14
12
10
8
6
20
30
40
50
60
70
80
90
100
110
120
Quantity
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Computing price elasticity (income constant)
Price Income Demand 13.00 3000.00 68.75 14.00 30
00.00 63.74 20.00 3000.00 44.20 21.00 3000.00 42
.03
?
?
13.00 4000.00 91.83 14.00 4000.00 85.17 20.00 4000
.00 59.20 21.00 4000.00 56.31
?
?
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Price Elasticity of Demand (Income 4000)
Price Income Demand 20.00 4000.00 59.20 21.00 4000
.00 56.31
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Price Elasticity of Demand (Income 3000)
Price Income Demand 20.00 3000.00 44.20 21.00 3000
.00 42.03
? -1.0257
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Computing income elasticity (price constant)
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Computing income elasticity (price constant)
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Demand Data on Q
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Income Elasticity of Demand
Price Income Demand 20.00 3000.00 44.20 20.00 4000
.00 59.20
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Normal and Inferior Goods
Normal goods have a positive income elasticity
Inferior goods have a negative income elasticity
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Necessities and Luxuries
Necessities typically have an income
elasticity between 0 and 1
Luxuries typically have an income
elasticity greater than 1
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Examples
Fresh Fruit
Meat
(Steak)
Potatoes
Food
Transportation (???)
Eating out
Cigarettes
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Cross-price Elasticity of Demand
The cross price elasticity of demand is defined
as the percentage change in the quantity
demanded of one good,
divided by the percentage change in the price of
a different good,
all other influences remaining constant
We denote the cross price elasticity of good i
for good j as ?ij where
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We can then rewrite this as
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Elasticities of Demand
Price elasticity measures movements along the
curve
Income elasticity measures shifts in the demand
curve
Cross-price elasticity measures shifts in the
demand curve
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Graphical Analysis
Demand for Q1
32
30
Price
28
26
24
22
20
18
16
14
12
10
8
20
30
40
50
60
70
80
90
100
Quantity
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Demand Data for Alternative Prices of Good 2
P1 P2 Income D1 13.00 10.00 3,000 68.75 14.00 1
0.00 3,000 63.74
20.00 10.00 3,000 44.20 21.00 10.00 3,000 42.03
13.00 50.00 3,000 72.45
14.00 50.00 3,000 67.17
20.00 50.00 3,000 46.60 21.00 50.00 3,000 44.31 22
.00 50.00 3,000 42.24
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Demand Data for Alternative Prices of Good 2
P1 P2 Income D1 13.00 10.00 3,000 68.75 14.00 1
0.00 3,000 63.74
20.00 10.00 3,000 44.20 21.00 10.00 3,000 42.03
13.00 50.00 3,000 72.45
14.00 50.00 3,000 67.17
20.00 50.00 3,000 46.60 21.00 50.00 3,000 44.31 22
.00 50.00 3,000 42.24
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Price Elasticity of Demand
Price Income Demand 20.00 3000.00 44.20 21.00 3000
.00 42.03
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Cross-price elasticity of demand for good 1 as
the price of good 2 changes from 10 to 50
P1 P2 Income D1 20.00 10.00 3,000 44.20 20.00 50.0
0 3,000 46.60
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Substitutes and Complements
Goods are said to be substitutes if ?ij gt 0
Demand goes up as other price goes up
Goods are said to be complements if ?ij lt 0
Demand goes down as other price goes up
Goods are said to be close substitutes if ?ij gtgt 0
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Substitutes
Beef and Pork
Rice Chex and Life Cereal
Ford and Dodge Cars
Margarine and Butter
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Complements
Printers and Printer Paper
Cars and Gasoline
Food and Entertainment
Televisions and VCRs
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Break
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Elasticity of Supply
The elasticity of supply is defined as the
percentage change in quantity supplied divided by
the percentage change in price,
all other influences remaining constant
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The elasticity of supply measures movements along
the supply curve
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Graphical Analysis
Supply of Shirts
400
375
Price
350
325
300
275
250
225
200
175
150
125
100
75
50
25
0
0
10
20
30
40
50
60
70
80
90
100
Quantity
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Supply Data
Q P 0 0 5 20 10 40 15 60 20 80 25 100 30 12
0 35 140 40 160 45 180 50 200 55 220 60 240
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Another Example of Elasticity of Supply
Q P 50 200 55 220
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Factors affecting the elasticity of supply
Supply will be more elastic, the more
alternatives producers of it have for
production.
Supply will be more elastic if the market is
defined narrowly.
Supply will be more inelastic if there are
biological or other lags in production
Supply will be much more elastic in the long run.
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Classification of the elasticity of supply
Inelastic supply
When the numerical value of the elasticity of
supply is between 0 and 1.0, we say that supply
is inelastic.
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Classification of the elasticity of supply
Elastic supply
When the numerical value of the elasticity of
supply is greater than 1.0, we say that supply
is elastic.
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Classification of the elasticity of supply
Unitary elastic supply
When the numerical value of the elasticity of
supply is equal to 1.0, we say that supply is
unitary elastic.
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Classification of the elasticity of supply
Perfectly inelastic - ?S 0
vertical
Very short run response
Perfectly elastic - ?S ?
horizontal
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Analysis of an agricultural market
Demand for food and food products is generally
price inelastic
Supply of many crops is stochastic due to
weather, disease, etc
Thus we tend to see large changes in price and
thus net farm income
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End of Presentation