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Income Elasticity of Demand: Normal and Inferior Goods

Definition: The percentage change in the quantity of a product demanded divided by the percentage change in consumer income causing the change in quantity demanded.

Since increases in consumer income will increase the demand for most goods, income elasticity measures the responsiveness of a demand for a good to a change in income. Specifically, it tells the analyst the percentage change in the quantity demanded for a good caused by a 1% increase in consumer income.

Calculation:

The type of product is the primary determinant of income elasticity of demand.

• Most products have positive income elasticity; normal goods have positive income elasticity.

• Necessities have low income elasticities (between 0 and 1); when income rises by 1%, the quantity demanded for necessities will increase by less than 1%.
• Luxuries have high income elasticities (greater than 1).

• A few commodities (inferior goods) have negative income elasticity; as income expands, the demand for them will decline. Examples of inferior goods are margarine, junk food, etc.

Cross-Price Elasticity of Demand: Substitutes and Complements

The cross elasticity of demand is a measure of the responsiveness of demand for a good to a change in the price of a substitute or a complement, other factors remaining the same. The formula for calculating the cross elasticity is:

• The cross elasticity of demand for a substitute is positive.
• The cross elasticity of demand for a complement is negative.

The following figure shows the increase in the quantity of pizza demanded when the price of a burger (a substitute for pizza) rises. The figure also shows the decrease in the quantity of pizza demanded when the price of a soft drink (a complement of pizza) rises.

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Subject 7. Demand Elasticities
tcome is determined by the price elasticity of demand. This conclusion is similar to that of total expenditures. Note that firms attempt to maximize profit (total revenue minus total cost), not revenue. <span>Income Elasticity of Demand: Normal and Inferior Goods Definition: The percentage change in the quantity of a product demanded divided by the percentage change in consumer income causing the change in quantity demanded. Since increases in consumer income will increase the demand for most goods, income elasticity measures the responsiveness of a demand for a good to a change in income. Specifically, it tells the analyst the percentage change in the quantity demanded for a good caused by a 1% increase in consumer income. Calculation: The type of product is the primary determinant of income elasticity of demand. Most products have positive income elasticity; normal goods have positive income elasticity. Necessities have low income elasticities (between 0 and 1); when income rises by 1%, the quantity demanded for necessities will increase by less than 1%. Luxuries have high income elasticities (greater than 1). A few commodities (inferior goods) have negative income elasticity; as income expands, the demand for them will decline. Examples of inferior goods are margarine, junk food, etc. Cross-Price Elasticity of Demand: Substitutes and Complements The cross elasticity of demand is a measure of the responsiveness of demand for a good to a change in the price of a substitute or a complement, other factors remaining the same. The formula for calculating the cross elasticity is: The cross elasticity of demand for a substitute is positive. The cross elasticity of demand for a complement is negative. The following figure shows the increase in the quantity of pizza demanded when the price of a burger (a substitute for pizza) rises. The figure also shows the decrease in the quantity of pizza demanded when the price of a soft drink (a complement of pizza) rises. <span><body><html>