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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 D1, I = 3000 D2, I = 4000 Quantity 32
Price D1, I = 3000 28 26 24 22 D2, I = 4000 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
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Price Elasticity of Demand (Income = 4000)
Price Income Demand
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Price Elasticity of Demand (Income = 3000)
Price Income Demand
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Computing income elasticity (price constant)
Price Income Demand
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Computing income elasticity (price constant)
Price Income Demand Q
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Demand Data on Q Price Income Demand 13.00 3000.00 68.75
I Q
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Income Elasticity of Demand
Price Income Demand
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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 D1, P2 = 10 D1, P2 = 50 Quantity
32 30 Price D1, P2 = 10 28 26 D1, P2 = 50 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 , , , , , , , , ,
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Demand Data for Alternative Prices of Good 2
P1 P2 Income D1 , , , , , , , , ,
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Price Elasticity of Demand
Price Income Demand
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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 , ,
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Substitutes and Complements
Goods are said to be substitutes if ij > 0 Demand goes up as other price goes up Goods are said to be complements if ij < 0 Demand goes down as other price goes up Goods are said to be close substitutes if ij >> 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 Quantity Price 400 375 350 325 300
275 250 225 200 175 150 125 100 75 50 25 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 30 120 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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Perfectly inelastic - S = 0
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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