Cross Elasticity and Income elasticity
Cross Elasticity of Demand : A measure of the degree of responsiveness of the demand of the first good to a change in the price of the second good, ceteris paribus
Income elasticity of demand : a measure of the degree of responsiveness of the demand to a change in income, ceteris paribus
Signs and magnitude
Determinants
Application
Income Level
Nature of good/ Degree of necessity 1) The YED for a good will be higher the more luxurious the good. ⭐ YED for high end private car is higher than those for low end private car.
The same good can be considered a luxury, normal good or a inferior good depending on the income of the consumer.
The YED will be higher the lower the level of income and vice versa
Formula YED = % of change in Demand / % of change in Income
YED = 0
YED < 0
Positive YED
With an increase in income, there is no change in the demand, ceteris paribus
1) Inferior goods 2) With an increase in income, there is a decrease in demand, ceteris paribus.
0<YED<1 1) Income inelastic 2) Necessities 3) With an increase in income, there will be a less than proportionate increase in the demand, ceteris paribus.
YED>1 1) Income elastic 2) Luxury goods 3)With an increase in income, there is a more than proportionate increase in demand, ceteris paribus
YED = 1 1) Unit income elasticity 2) With an increase in income, there is a proportionate increase in the demand, ceteris paribus
For government
For firms and producers
Changes in income level can help to project changes in tax revenue and other government policies
Targeting different income groups in different locations ( niche markets) ✏So that appropriate prices and quantities can be set to suit the demands of perspective income-level groups
Determines 1) Responses to changes in national income levels during economic boom or recession , dependent on type of good 2) For luxury goods, demand increases rapidly during an economic boom. Hence, firms may choose to increase production levels, make the product more price elastic through campaigning, stock accumulation and expansion. 3) For inferior goods, firms must do the reverse of luxury goods during economic boom.
Sign and Magnitude
Applications
Magnitude
Positive
Negative
Formula : XED = % of change for Good A / % of change for Good B
For Firms and producers
Towards Positive infinity
Towards 0
1) Substitutes for one another. 2) A decrease in the price of one good leads to a fall in demand for the other, vice versa.
1) Complements of one another. 2) A decrease in the price of one good leads to a rise in the demand of the other and vice versa
1) The closer the substitute or complement, the bigger the effect on the demand of the good when the price of the substitute or complement changes. 2) When 2 goods are perfect substitutes, XED tends to go towards positive infinity and negative infinity when they are perfect complements.
1)When 2 goods are less closely related, there is a smaller effect on the demand of one good when the price of the substitute or complement changes. 2) When 2 goods are independent or unrelated, XED = 0.
When XED<0, complements change in price. Firms can have join promotions such as discounts
When XED>0 , substitutes change in price. Firms react by either employing pricing strategy to recoup revenue or employ non pricing strategy [ product differentiation] to make the demand for their good more price elastic