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Income Elasticity of Demand + Cross Elasticity of Demand (YED…
Income Elasticity of Demand + Cross Elasticity of Demand
YED
Sign & Magnitude
+YED: normal goods
Income inelastic (0<PED<1): necessities Income elastic (YED>1): luxury goods
-YED: inferior goods
Consumption:arrow_up: with :arrow_down:income
Determinants
(NL)
Nature of Good/ Degree of Necessity
Necessities
Positive and low as D:arrow_up: with income but desire for increased consumption usually does not grow proportionately
Luxury Goods
Positive and high as generally prefer to spend higher % of extra income on them to enhance quality of life when affluent
Considered first in cutting back expenditure when income:arrow_down:
Level of Income/ Affluence of Consumers
Same good may be inferior/normal/luxury depending on income level
"Inferiority" relates to affordability, not good's quality
Applications
Consumers
:arrow_up:NI likely to lead to :arrow_up:wages
D for luxury goods likely to :arrow_up:>proportionately, significant :arrow_up:expenditure
D for necessities :arrow_up:<proportionately
D for inferior goods likely :arrow_down:
Gov.
Predict D patterns according to changes in income levels and project changes to tax revenue and policies
Firms
Respond to changes in income levels
:arrow_up:Income: :arrow_up:current production/stocks of luxury goods during anticipated D:arrow_up:, make product more up-market to make D more Y-elastic eg. through advertising
Recession: :arrow_down:production of luxury goods, introduce lower-end version as D:arrow_up: for inferior goods when Y:arrow_down:
YED about output decisions, not pricing.
offering lower-end services in recession ->timing of introducing diff. services, YED, not PED
Target diff. income groups in diff. locations
Segment market into diff. income groups, set P&Q accordingly to maximize revenue
Definition
% :arrow_up_small:QD / %:arrow_up_small:income = (:arrow_up_small:QD/:arrow_up_small:Y)(Y/QD)
PED: gradient of D curve
YED: extent of shift of D curve
degree of responsiveness of D to change in consumer's income, cp
CED
Degree of responsiveness of D for a good to change in P of another good,cp
CED = %:arrow_up_small:QD of X/%:arrow_up_small:P of Y = (:arrow_up_small:QD of X/:arrow_up_small:P of Y)/(P of Y/QD of X)
Sign
+CED: Substitutes
:arrow_down:P of one good leads to :arrow_down:D for other good
-CED: Complements
Magnitude
Stronger substitute/complement ->bigger effect of :arrow_up_small:P, larger CED
CED=0 for unrelated goods
Applications
React to rivals'pricing actions, not PED which does not include rivals' pricing
Firms
React to rival selling substitutes
Pricing strategy: match P cut to prevent consumers turning to cheaper alternatives
Non-P strategy: product differentiation eg. quality, to lower degree of substitutability
React to firms selling complements
eg. joint promotions
Consumers
:arrow_up_small:P substitutes
If small CED (weak sub), :arrow_up:D and consumer expenditure on sub is insignificant
:arrow_up_small:P complements:
Strong complements need to be jointly consumed, :arrow_up_small:D can be significant