Cross Elasticity and Income Elasticity

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Cross Elasticity and Income Elasticity
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Background

• Dominos Pizza has a BIG problem! Burger King
  just cut its prices. Pat, the manager of
  Dominos, knows that pizzas and burgers are
  substitutes. He also knows that when the price
  of a substitute for pizza falls, the demand for
  pizza decreases.
• How much will the quantity of pizza bought
  decrease if Pat maintains his current price?

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Background

• Also, pizza and soda are complements. He knows
  that if the price of a complement of pizza falls,
  the demand for pizza increases. So could he keep
  his customers by cutting the price he charges for
  soda? But how much must he cut the price of soda
  to keep selling the same quantity of pizza with
  cheaper burgers at Burger King?

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Cross Elasticity of Demand

• Measure of the responsiveness of the demand for a
  good to a change in the price of a substitute or
  complement when other things remain the same.

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Cross Elasticity of Demand

• Price of a burger falls by 10, the quantity of
  pizza demanded decreases by 5.
• Cross elasticity of demand for a substitute is
  positive. A FALL in the price of a substitute
  brings a DECREASE in the quantity demanded for a
  good
• The quantity demanded of a good and the price of
  one of it substitute changes in the same direction

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Cross Elasticity of Demand

• When the price of soda falls by 10, the quantity
  of pizza demanded increases by 2.
• Cross elasticity of demand for a complement is
  negative. A FALL in the price of a complement
  brings an INCREASE in the quantity demanded of
  the good.
• The quantity demanded of a good and the price of
  one of its complement change in opposite
  directions

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Cross Elasticity of Demand

• Pizzas and burgers are substitutes.
• When the price of a burger falls, the demand for
  pizza decreases.
• Cross elasticity of demand is positive

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Cross Elasticity of Demand

• Pizzas and soda are complements.
• When the price of soda falls, the demand for
  pizza increases.
• Cross elasticity of demand is negative.

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Income Elasticity

• Measure of the responsiveness of the demand for a
  good to a change in income when other things
  remain the same.
• Income elasticity of demand falls into three
  ranges
• Greater than 1 (normal good, income elastic)
• Between zero and 1 (normal good, income
  inelastic)
• Less than zero (inferior good)

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Income Elasticity

• As income increase,
• items that have an income elastic demand take an
  increasing share of income
• Items that have an income elastic demand take a
  decreasing share of income
• Items that have a negative income elasticity of
  demand take an absolutely smaller amount of income

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Cross Elasticity and Income Elasticity Notes
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Background

• Dominos Pizza has a BIG problem! Burger King
  just cut its prices. Pat, the manager of
  Dominos, knows that pizzas and burgers are
  substitutes. He also knows that when the price
  of a substitute for pizza falls, the demand for
  pizza decreases.
• How much will the quantity of pizza bought
  decrease if Pat maintains his current price?

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Background

• Also, pizza and soda are ______________. He
  knows that if the price of a complement of pizza
  falls, the demand for pizza increases. So could
  he keep his customers by cutting the price he
  charges for soda? But how much must he cut the
  price of soda to keep selling the same quantity
  of pizza with cheaper burgers at Burger King?

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Cross Elasticity of Demand
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Cross Elasticity of Demand

• Price of a burger falls by 10, the quantity of
  pizza demanded decreases by 5.
• Cross elasticity of demand for a substitute is
  positive. A ________ in the price of a
  substitute brings a ____________ in the quantity
  demanded for a good
• The quantity demanded of a good and the price of
  one of it substitute changes in the same direction

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Cross Elasticity of Demand

• When the price of soda falls by 10, the quantity
  of pizza demanded increases by 2.
• Cross elasticity of demand for a complement is
  negative. A ________ in the price of a
  complement brings an _____________ in the
  quantity demanded of the good.
• The quantity demanded of a good and the price of
  one of its complement change in opposite
  directions

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Cross Elasticity of Demand
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Cross Elasticity of Demand
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Income Elasticity

• Measure of the responsiveness of the demand for a
  good to a change in income when other things
  remain the same.
• Income elasticity of demand falls into three
  ranges
• Greater than 1 (normal good, income _____)
• Between zero and 1 (normal good, income
  _____________)
• Less than zero (_____________)

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Income Elasticity

• As income increase,
• items that have an income ___________demand take
  an ____________ share of income
• Items that have an income ___________elastic
  demand take a ________________ share of income
• Items that have a __________ income elasticity of
  demand take an absolutely ________________amount
  of income