Elasticity of Income & Elasticity of Income & Cross-Price ElasticityCross-Price Elasticity

Tim OddTim Odd

Elasticity of IncomeElasticity of Income

Measures the relationship between a Measures the relationship between a change in quantity demanded for a change in quantity demanded for a good and a change in income.good and a change in income.

Elasticity of Income = Elasticity of Income = % Change in Demand% Change in Demand / / % Change in Income% Change in Income

Normal GoodsNormal Goods

Normal goods have Normal goods have positivepositive income income elasticity, so as income rises, demand elasticity, so as income rises, demand does as well.does as well.

Normal Necessities have income elasticity Normal Necessities have income elasticity between 0 and +1, so demand rises less between 0 and +1, so demand rises less than proportionally to income.than proportionally to income.

Luxury Goods have an income elasticity Luxury Goods have an income elasticity >+1, so demand rises more than >+1, so demand rises more than proportionally to income.proportionally to income.

Inferior GoodsInferior Goods

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

Elasticity of IncomeElasticity of Income

Product RangesProduct Ranges

Income elasticity varies within Income elasticity varies within product ranges (group of similar product ranges (group of similar products targeted at differing products targeted at differing economic groups).economic groups).

Similar products of varying qualities Similar products of varying qualities will have different income elasticities.will have different income elasticities.

e.g. First-class cabins on a plane vs. e.g. First-class cabins on a plane vs. Economy; First-class would have a Economy; First-class would have a higher income elasticity.higher income elasticity.

Counter-Cyclical ProductsCounter-Cyclical Products

Because inferior goods tend to have Because inferior goods tend to have negative income elasticity, they are negative income elasticity, they are counter-cyclicalcounter-cyclical, and trend in the , and trend in the opposite direction of the economy.opposite direction of the economy.

Consumer demand for counter-cyclical Consumer demand for counter-cyclical products will products will increaseincrease if income falls, just if income falls, just as it will decrease when income rises.as it will decrease when income rises.

Counter-cyclical products are not Counter-cyclical products are not necessarily 'inferior' goods. (e.g. Sales of necessarily 'inferior' goods. (e.g. Sales of items at hardware stores vs. Furniture items at hardware stores vs. Furniture stores)stores)

Cyclical vs. Counter-Cyclical Cyclical vs. Counter-Cyclical ProductsProducts

Cross Price ElasticityCross Price Elasticity

Measures the change in demand for Measures the change in demand for a good following a change in price of a good following a change in price of another good.another good.

CPE = CPE = % Change in Demand of Good A% Change in Demand of Good A / / % Change in Price of Good B% Change in Price of Good B

Substitute goodsSubstitute goods

When the price of a good increases, When the price of a good increases, the demand for substitute goods the demand for substitute goods increases. When the price of a good increases. When the price of a good decreases, the demand for substitute decreases, the demand for substitute goods decreases.goods decreases.

Thus, the cross price elasticity Thus, the cross price elasticity demand is positive for substitutesdemand is positive for substitutes

Complimentary GoodsComplimentary Goods

Complimentary goods share demand, so Complimentary goods share demand, so when the price of one increases, the when the price of one increases, the demand for the other will decrease.demand for the other will decrease.

The cross price elasticity demand for The cross price elasticity demand for complimentary goods is negative, and is complimentary goods is negative, and is more negative for closer related goods.more negative for closer related goods.

Example: Game consoles & their games Example: Game consoles & their games have a more negative elasticity than pizza have a more negative elasticity than pizza dough and tomatoes.dough and tomatoes.

ADD CHART HEREADD CHART HERE

YA DINGUSYA DINGUS Complimentary Goods + CPEComplimentary Goods + CPE

Relatedness of productsRelatedness of products

Unrelated products will have zero Unrelated products will have zero cross price elasticity on one another.cross price elasticity on one another.

Example: A change in the price of a Example: A change in the price of a piece of fine art will have no effect on piece of fine art will have no effect on the demand of chocolate bars.the demand of chocolate bars.

Cross-Price ElasticityCross-Price Elasticity

Brand Identity & Cross Price Brand Identity & Cross Price ElasticityElasticity

Products with a loyal customer base Products with a loyal customer base are less sensitive to changes in price are less sensitive to changes in price of competing goods; lowering cross of competing goods; lowering cross price elasticity demand.price elasticity demand.

Example: Starbucks takes a relatively Example: Starbucks takes a relatively small hit to sales when the price of small hit to sales when the price of Tim Horton's coffee drops.Tim Horton's coffee drops.