Elasticity of Income & Cross-Price Elasticity Tim Odd

Elasticity of Income Measures the relationship between a change in quantity demanded for a good and a change in income. Measures the relationship between a change in quantity demanded for a good and a change in income. Elasticity of Income = % Change in Demand / % Change in Income Elasticity of Income = % Change in Demand / % Change in Income

Normal Goods Normal goods have positive income elasticity, so as income rises, demand does as well. Normal goods have positive income elasticity, so as income rises, demand does as well. Normal Necessities have income elasticity between 0 and +1, so demand rises less than proportionally to income. Normal Necessities have income elasticity between 0 and +1, so demand rises less than proportionally to income. Luxury Goods have an income elasticity >+1, so demand rises more than proportionally to income. Luxury Goods have an income elasticity >+1, so demand rises more than proportionally to income.

Inferior Goods Inferior goods have negative income elasticity, so as income rises, demand falls. This is because consumers will begin to buy superior goods as they become able to afford them. Inferior goods have negative income elasticity, so as income rises, demand falls. This is because consumers will begin to buy superior goods as they become able to afford them.

Elasticity of Income

Product Ranges Income elasticity varies within product ranges (group of similar products targeted at differing economic groups). Income elasticity varies within product ranges (group of similar products targeted at differing economic groups). Similar products of varying qualities will have different income elasticities. Similar products of varying qualities will have different income elasticities. e.g. First-class cabins on a plane vs. Economy; First-class would have a higher income elasticity. e.g. First-class cabins on a plane vs. Economy; First-class would have a higher income elasticity.

Counter-Cyclical Products Because inferior goods tend to have negative income elasticity, they are counter-cyclical, and trend in the opposite direction of the economy. Because inferior goods tend to have negative income elasticity, they are counter-cyclical, and trend in the opposite direction of the economy. Consumer demand for counter-cyclical products will increase if income falls, just as it will decrease when income rises. Consumer demand for counter-cyclical products will increase if income falls, just as it will decrease when income rises. Counter-cyclical products are not necessarily 'inferior' goods. (e.g. Sales of items at hardware stores vs. Furniture stores) Counter-cyclical products are not necessarily 'inferior' goods. (e.g. Sales of items at hardware stores vs. Furniture stores)

Cyclical vs. Counter-Cyclical Products

Cross Price Elasticity Measures the change in demand for a good following a change in price of another good. Measures the change in demand for a good following a change in price of another good. CPE = % Change in Demand of Good A / % Change in Price of Good B CPE = % Change in Demand of Good A / % Change in Price of Good B

Substitute goods When the price of a good increases, the demand for substitute goods increases. When the price of a good decreases, the demand for substitute goods decreases. When the price of a good increases, the demand for substitute goods increases. When the price of a good decreases, the demand for substitute goods decreases. Thus, the cross price elasticity demand is positive for substitutes Thus, the cross price elasticity demand is positive for substitutes

Complimentary Goods Complimentary goods share demand, so when the price of one increases, the demand for the other will decrease. Complimentary goods share demand, so when the price of one increases, the demand for the other will decrease. The cross price elasticity demand for complimentary goods is negative, and is more negative for closer related goods. The cross price elasticity demand for complimentary goods is negative, and is more negative for closer related goods. Example: Game consoles & their games have a more negative elasticity than pizza dough and tomatoes. Example: Game consoles & their games have a more negative elasticity than pizza dough and tomatoes.

ADD CHART HERE YA DINGUS YA DINGUS Complimentary Goods + CPE Complimentary Goods + CPE

Relatedness of products Unrelated products will have zero cross price elasticity on one another. Unrelated products will have zero cross price elasticity on one another. Example: A change in the price of a piece of fine art will have no effect on the demand of chocolate bars. Example: A change in the price of a piece of fine art will have no effect on the demand of chocolate bars.

Cross-Price Elasticity

Brand Identity & Cross Price Elasticity Products with a loyal customer base are less sensitive to changes in price of competing goods; lowering cross price elasticity demand. Products with a loyal customer base are less sensitive to changes in price of competing goods; lowering cross price elasticity demand. Example: Starbucks takes a relatively small hit to sales when the price of Tim Horton's coffee drops. Example: Starbucks takes a relatively small hit to sales when the price of Tim Horton's coffee drops.