Income Elasticity

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Income Elasticity (Normal Goods)

• Income Elasticity
• (Normal Goods)

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Income Elasticity normal goods
Income elasticity is a measure of the change in
demand a shift of the demand function that
is caused by a change in income.
ey º
The increase in income, DY, increases demand to
D2. The increase in demand results in a
larger quantity being purchased at the
same Price P1..
Where Y income
At a price of P1 , the quantity demanded given
the demand D is Q1 .
D is the demand function when
the income is Y1 .
Due to increase in income,
For a normal good an increase in income to Y2
will shift the demand to the right. This is
an increase in demand to D2.
D Y gt 0 D Qgt 0 therefore, ey gt0 it is
positive
Q1
Q2
.
3
A decrease in income is associated with a
decrease in the demand for a normal good.
ey º
For a decrease in income -D Y, the demand
decreases i.e. shifts to the left,
At income Y1, the demand D1 represents the
relationship between P and Q. At a price P1
the quantity Q1 is demanded.
at the price P1 , a smaller Q2
will be purchased.
A decrease in income,
DY lt 0 negative DQ lt 0 negative so,
ep gt 0 positive
For either an increase or decrease in income the
ep is positive. A positive relationship
positive correlation between D Y and D Q is
evidence of a normal good.
Q1
Q2
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When income elasticity is positive, the good is
considered a normal good. An increase in
income is correlated with an increase in the
demand function.
A decrease in income is
associated with a decrease in the demand
function.
For both increases and decreases in income, ey
is positive
The greater the value of ey, the more responsive
buyers are to a change in their incomes.
When the value of ey is greater than 1, it is
called a superior good.
The D Qx is greater than the D Y. Buyers
are very responsive to changes in income.
Sometimes superior goods are called luxury
goods.
.
.
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Income Elasticity (Inferior Goods)

• Income Elasticity
• (Normal Goods)

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There is another classification of goods where
changes in income shift the demand function in
the opposite direction.
An increase in income DY reduces demand.
An increase in income reduces the amount that
individuals are willing to buy at each price of
the good. Income elasticity is negative - ey
The greater the absolute value of - ey, the more
responsive buyers are to changes in income
Q1
Q2
.
.
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Decreases in income increase the demand for
inferior goods.
A decrease in income -DY increases demand.
A decrease in income -D Y results in an
increase in demand, the income elasticity of
demand is negative
For both increases and decreases in income the
income elasticity is negative for inferior
goods. The greater the absolute value of ey,
the more responsive buyers are to changes in
income
Q1
Q2
.
.
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Income Elasticity

• Income elasticity ey is a measure of the effect
  of an income change on demand. Can be
  calculated as point or arc.
• ey gt 0, positive is a normal or superior good
  an increase in income increases demand, a
  decrease in income decreases demand.
• 0 lt ey lt 1 is a normal good
• 1 lt ey is a superior good
• ey lt 0, negative is an inferior good

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Examples of ey

• normal goods, 0 lt ey lt 1 , (between 0 and 1)
• coffee, beef, Coca-Cola, food, Physicians
  services, hamburgers, . . .
• Superior goods, ey gt 1, (greater than 1)
• movie tickets, foreign travel, wine, new cars, .
  . .
• Inferior goods, ey lt 0, (negative)
• flour, lard, beans, rolled oats, . . .

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Cross-price elasticity of demand,
exy substitutes

• Income Elasticity
• (Normal Goods)

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When the price of mutton increases, it will tend
to increase the demand for beef. People will
substitute beef, which is relatively cheaper,
for mutton, which is relatively more expensive.
When beef is 2, Qb beef is purchased.
When mutton is 1.50, Qm is purchased.
Pb
Pm
price of mutton
at Pb 2 more beef will be bought to
substitute for the smaller quantity
of mutton.
price of mutton increases
price of beef
The quantity demanded of mutton decreases.
2
for an increase in Pmutton,
Db
demand for beef increases
Dp
beef/ut
Qb
Qb
Qm
Qm
mutton/ut
.
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• Cross-price elasticity
• In the case of beef and mutton
• the ebm is not the same as emb
• ebm is the change in the demand for beef with
  respect to a change in the price of mutton
• emb is the change in the demand for mutton with
  respect to a change in the price of beef
• beef may not be a good substitute for mutton
• mutton may not be a good substitute for beef

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The cross elasticity of the demand for beef with
respect to the price of mutton, ebeef-mutton or
ebm can be calculated
An increase in the price of mutton,
causes an increase in the demand for beef.
cross elasticity is positive
A decrease in the price of mutton,
causes a decrease in the demand for beef.
If goods are substitutes, exy will be positive.
The greater the coefficient, the more likely
they are good substitutes.
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Cross-price elasticity of demand,
exy Compliments

• Income Elasticity
• (Normal Goods)

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as more crayons are purchased, the demand
for colour books increases.
Pc
Pc
a decrease in the price of crayons,
At the same price a larger quantity will
be bought
P1
3
Dp
Dc
crayons
colour books
Q1
2500
2000
DQb
increases the quantity demanded of crayons
for compliments, the cross elasticity is
negative for price increase or decrease.
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• Cross-Price Elasticity
• exy gt 0 positive, suggests substitutes, the
  higher the coefficient the better the substitute
• exy lt 0 negative, suggests the goods are
  compliments, the greater the absolute value the
  more complimentary the goods are
• exy 0, suggests the goods are not related

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Elasticity of Supply

• Income Elasticity
• (Normal Goods)

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Elasticity of Supply

• Elasticity of supply is a measure of how
  responsive sellers are to changes in the price of
  the good.
• Elasticity of supply ep is defined

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Given a supply function,
at a price P1, Q1 is produced and offered for
sale.
a larger quantity, Q2, will be produced and
offered for sale.
At a higher price P2,
P2
The increase in price DP , induces a larger
quantity goods DQfor sale.
DP
P1
The more responsive sellers are to DP, the
greater the absolute value of es.
DQ
The supply function is flatterormore elastic
Q1
Q2
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The supply function is a model of sellers
behavior.
a perfectly inelastic supply, es 0
Sellers behavior is influenced by
1. technology
2. prices of inputs
a perfectly elastic supply
es is undefined.
3. time for adjustment market period short
run long run very long run
4. expectations
5. anything that influences costs of
production taxes regulations, . . .
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• Summary
• Price elasticity of demand measures a move on a
  demand function caused by change in price/arc or
  point
• elastic, inelastic or unitary elasticity
• income elasticity measures a shift of a demand
  function associated with a change in income
• superior, normal, and inferior
• cross elasticity
• measure the shift of a demand function for a good
  associated with the change in the price of a
  related good
• compliment/substitute
• price elasticity of supply measures move on a
  supply curve

• Income Elasticity
• (Normal Goods)

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• Reference Principles of Economics, 6/e by Karl
  Cas, Ray Fair
• Slides prepared by Fernando Quijano and Yvonn
  Quijano

• Income Elasticity
• (Normal Goods)