1. AEC 506: INTRODUCTION TO LIVESTOCK ECONOMICS AND MARKETING TRIMESTER TRADE DIPLOMA IN ANIMAL Husbandry YEAR 2
LECTURE 3: ELASTICITY- PRICE, INCOME AND CROSS APPLICATION OF ELASTICITY IN MANAGERIAL DECISION
Lecturer: Vashnika Narayan

2. Elasticity = % change in quantity
What is 'Elasticity’
Elasticity is a measure of a variable's sensitivity to a change in another variable. In economics, elasticity refers the degree to which individuals (consumers/producers) change their demand/amount supplied in response to price or income changes.
Elasticity = % change in quantity
% change in price

3. Elasticity is used to assess the change in consumer demand as a result of a change in the good's price. When the value is greater than 1, this suggests that the demand for the good/service is affected by the price, whereas a value that is less than 1 suggest that the demand is insensitive to price.

4. IEoD = %change in quantity demanded
Income Elasticity of Demand
measures the responsiveness of demand due to an increase or decrease in consumer income.
IEoD = %change in quantity demanded
% change in income
For example, if the quantity demanded for a good increases for 15% in response to a 10%increase in income, the income elasticity of demand would be 15% / 10% = 1.5. The degree to which the quantity demanded for a good changes in response to a change in income depends on whether the good is a necessity or a luxury.

5. Characterizing Income Elasticity
Normal Goods (E>0). These are goods whose consumption increases with an increase in income.
An example of a normal good is the type of clothes you buy. While you are in college and your income is low, you may shop at Wal-Mart for your clothing. However, after you complete your degree, and you are making a lot of money as an economist, you are more likely to buy more expensive clothes from retailers in a shopping mall. In other words, your consumption increases as your income increases as you buy more expensive clothing.

6. Necessity (E<1). These are goods whose consumption increases an amount smaller than an increase in income.
An example of a necessity is drinking water. While you may upgrade with an increase in income, however, it is unlikely that your consumption of water will increase an amount more than your increase income. For instance, if your income were to increase by 25 percent, you will probably not consume 25 percent more drinking water.

7. Luxury Good (E>1). These are goods whose consumption increases an amount larger than an increase in income.
An example of a luxury good is a round of golf. With low income, your consumption of rounds of golf will likely be zero. However, once your income rises enough to afford to play, your increase in rounds of golf will probably be higher than the increase in income. In other words, once you make enough money to play the first round of golf, your increase in round of golf consumption will be 100 percent while the increase in income may have only been 15 percent.

8. Inferior Good (E<0). These are goods whose consumption decreases with an increase in income.
Example: When income is low, it makes sense to ride the bus. But as income increases, people stop riding the bus and start buying cars. It's acceptable to most people to ride the bus when they can't afford a car. But as soon as they can afford one, they buy a car and stop riding the bus. Bus riding declines as income increases.

9. Types of Income Elasticity of demand
1. Positive income elasticity of demand (EY>0) If there is direct relationship between income of the consumer and demand for the commodity, then income elasticity will be positive. That is, if the quantity demanded for a commodity increases with the rise in income of the consumer and vice versa, it is said to be positive income elasticity of demand. For example: as the income of consumer increases, they consume more of superior (luxurious) goods. On the contrary, as the income of consumer decreases, they consume less of luxurious goods.

10. Positive income elasticity can be further classified into three types: •Income elasticity greater then unity (EY > 1) If the percentage change in quantity demanded for a commodity is greater than percentage change in income of the consumer, it is said to be income greater than unity. For example: When the consumer’s income rises by 3% and the demand rises by 7%, it is the case of income elasticity greater than unity.
Consumers income ∆Y < ΔD Y D Y1 ∆Y ΔD Q Q1 Quantity demanded for superior goods

11. •Income elasticity equal to unity (EY = 1) If the percentage change in quantity demanded for a commodity is equal to percentage change in income of the consumer, it is said to be income elasticity equal to unity. For example: When the consumer’s income rises by 5% and the demand rises by 5%, it is the case of income elasticity equal to unity.
Consumers income ∆Y = ΔD D Y1 ∆Y Y ΔD
Q Q1
Quantity demanded for superior goods

12. • Income elasticity less then unity (EY < 1)
If the percentage change in quantity demanded for a commodity is less than percentage change in income of the consumer, it is said to be income greater than unity. For example: When the consumer’s income rises by 5% and the demand rises by 3%, it is the case of income elasticity less than unity.

13. 2. Negative income elasticity of demand ( EY<0)
If there is inverse relationship between income of the consumer and demand for the commodity, then income elasticity will be negative. That is, if the quantity demanded for a commodity decreases with the rise in income of the consumer and vice versa, it is said to be negative income elasticity of demand. For example:
As the income of consumer increases, they either stop or consume less of inferior goods.

14. 3. Zero income elasticity of demand ( EY=0)
If the quantity demanded for a commodity remains constant with any rise or fall in income of the consumer and, it is said to be zero income elasticity of demand. For example: In case of basic necessary goods such as salt, kerosene, electricity, etc. there is zero income elasticity of demand

15. Significance of Income Elasticity of Demand
While price elasticity plays a significant role in pricing of a product to maximize the total revenue of an organization in the short run, income elasticity of demand is important for production planning and management in the long run.

16. 1. Helping in investment decisions:
Refers to one of the major significance of income elasticity of demand. In developing countries, such as India, the rate of growth of national income is not steady as it is in case of developed countries. Moreover in developing countries, rise in national income does not result in immediate increase in the demand for certain goods.
The concept of national income is very important for sellers as it helps them to allocate their resources in different industries. Generally, sellers prefer to invest in industries where the demand for goods is more with respect to proportionate change in the income or where the income elasticity of demand is greater than zero (ey>1).
For example, the demand for durable goods, such as vehicles, furniture, and electrical appliances, increases in response to increase in the national income. In such industries, sellers earn high profits when there is increase in national income. On the other hand, industries with low income elasticity (ey<1), there is a gradual increase in demand for goods, whereas the demand for goods having negative income elasticity declines when the national incomes grows.

17. 2. Forecasting demand:
Refers to the fact that income elasticity of demand help in anticipating the demand for goods in future. If change in income is certain, there would be a major change in the demand for goods. This is due to the fact that if consumers are aware of change in income, they may change their tastes and preferences for certain goods.
On the other hand, if the change in income is temporary, there would be a slow change in the demand. However, the demand for goods in future is also influenced by various factors other than income.

18. 3. Categorizing goods:
Implies that income elasticity of demand helps in classifying goods, such as normal goods, essential goods, or inferior goods. The classification of goods enables sellers to select the goods to be produced and the quantity of goods to be produced. Apart from this, it also helps sellers to decide the income group to whom the goods should target.

19. Following assumptions are made while classifying goods:
A good would be a normal good, if the income elasticity of demand is positive.
A good would be an inferior good, if the income elasticity of demand is negative. For example, millet is inferior to wheat; therefore, the demand for millet is negative.
A good would be a luxury good, if income elasticity of demand is positive and greater that one (ey> 1). For example, the demand for cars and air conditioners is income elastic.
A good would be an essential good, if income elasticity of demand is positive but less than one (ey< 1). For example, food grains and clothes.
A good would be neutral, if the income elasticity of demand is zero (ey=0).

20. Cross elasticity of demand
Cross elasticity of demand (XED) measures the percentage change in quantity demand for a good after the change in price of another. XED = % change in Q.D. good A % change in P good B

21. Substitute goods
For goods which are substitutes, we expect to see a positive cross elasticity of demand. If the price of bread increases, people will buy more of an alternative, such as buns or biscuits
Weak substitutes like tea and coffee will have a low cross elasticity of demand

22. Complements goods
These are goods which are used together, therefore the cross elasticity of demand is negative. If the price of one goes up, you will buy less of both goods.
For example, if the price of DVD players goes down, you will buy more DVD players and also there will be a increase in demand for DVD disks.
If the price of Samsung mobile phones goes down, we will also buy more Samsung related phone apps.

23. Example 1: The quantity demanded or product A has increased by 12% in response to a 15% increase in price of product B. Calculate the cross elasticity of demand and tell whether the product pair is (a) apples and oranges, or (b) cars and gas.
Cross elasticity of demand = % change in quantity demanded of A ÷ % change in price of B = 12%/15% = 0.67.
Since the cross elasticity of demand is positive, product A and B are substitute goods. They are most likely apples and oranges.

24. Acknowledgement
Special appreciation to Ms. Vashnika Narayan for preparing this lecture.