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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
%Q D
Income elasticity of demand I
%I

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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

Price

Demand for Q
32
30
28
26
24
22
20
18
16
14
12
10
8
6

D1, I = 3000
D2, I = 4000

20

30

40

50

60

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70

80

90

100 110 120

Quantity

Computing price elasticity (income constant)

Price
13.00
14.00
20.00
21.00
13.00
14.00
20.00
21.00

Income
3000.00
3000.00
3000.00
3000.00
4000.00
4000.00
4000.00
4000.00

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Demand
68.75
63.74
44.20

42.03
91.83
85.17
59.20

56.31

Price Elasticity of Demand (Income = 4000)

Price Income Demand
D
%Q
20.00 4000.00 59.20
D
21.00 4000.00 56.31
%P

(Q1 Q0 ) (P1 P0 )

( P1 P0 ) ( Q1 Q0 )

(56.3159.20)
(21 20)

(21 20)
(56.31 59.20)

(
2.89)
(41)

1.0257
(1)
(115.51)
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Price Elasticity of Demand (Income = 3000)

Price Income Demand
D
%Q
20.00 3000.00 44.20
D
21.00 3000.00 42.03
%P

(Q1 Q0 ) (P1 P0 )

( P1 P0 ) ( Q1 Q0 )

(44.2042.03)
( 21 20)

( 21 20)
( 44.20 42.03 )
(
2.17) (41)

1.03177 -1.0257
(1)
(86.23)
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Computing income elasticity (price constant)

Price
13.00
14.00
20.00
21.00
13.00
14.00
20.00
21.00

Income
3000.00
3000.00
3000.00
3000.00
4000.00
4000.00
4000.00
4000.00

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Demand
68.75
63.74
44.20
42.03
91.83
85.17
59.20
56.31

Computing income elasticity (price constant)

Price
13.00
14.00
20.00
21.00
13.00
14.00
20.00
21.00

Income
3000.00
3000.00
3000.00
3000.00
4000.00
4000.00
4000.00
4000.00

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Demand
68.75
63.74
44.20
42.03
91.83
85.17
59.20
56.31

Demand Data on Q

Price
13.00
14.00
20.00
21.00
13.00
14.00
20.00
21.00

Income
3000.00
3000.00
3000.00
3000.00
4000.00
4000.00
4000.00
4000.00

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Demand
68.75
63.74
44.20
42.03
91.83
85.17
59.20
56.31

Income Elasticity of Demand

D

%Q
I
%I

PriceIncome Demand
20.00
3000.00 44.20
20.00
4000.00 59.20

(Q1 Q0 ) (I1 I0 )

( I1 I0 ) ( Q1 Q0 )
(44.259.20) (3,000 4,000)

(3,000 4,000) (44.2 59.20)

(
15) (7,000)

1.01547
(
1000) (103.4)
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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
D

%Qi
ij
%Pj
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We can then rewrite this as

D

%Qi
ij
%Pj

1
(Qi

0
Qi )

1
(Pj

0
Pj )

1
( Pj

0
Pj )

1
( Qi

0
Qi )

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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

Price

Demand for Q1
32
30
28
26
24
22
20
18
16
14
12
10
8

D1, P2 = 10
D1, P2 = 50

20

30

40

50

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60

70

80

90 100

Quantity

Demand Data for Alternative Prices of Good 2

P1
13.00
14.00
20.00
21.00
13.00
14.00
20.00
21.00
22.00

P2
10.00
10.00
10.00
10.00
50.00
50.00
50.00
50.00
50.00

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Income
3,000
3,000
3,000
3,000
3,000
3,000
3,000
3,000
3,000

D1
68.75
63.74
44.20
42.03
72.45
67.17
46.60
44.31
42.24

Demand Data for Alternative Prices of Good 2

P1
13.00
14.00
20.00
21.00
13.00
14.00
20.00
21.00
22.00

P2
10.00
10.00
10.00
10.00
50.00
50.00
50.00
50.00
50.00

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Income
3,000
3,000
3,000
3,000
3,000
3,000
3,000
3,000
3,000

D1
68.75
63.74
44.20
42.03
72.45
67.17
46.60
44.31
42.24

Price Elasticity of Demand

Price Income Demand
D
%Q
20.00 3000.00 44.20
D
21.00 3000.00 42.03
%P

(Q1 Q0 ) (P1 P0 )

(P1 P0 ) ( Q1 Q0 )
(44.2042.03)
( 20 21 )

( 20 21)
( 44.2 42.03)
(2.17) (41)

1.03177
(
1) (86.23)
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Cross-price elasticity of demand for good 1

as the price of good 2 changes from $10 to $50

P1
20.00
ij
%P2
20.00
1
0
1
(Q1 Q1 ) (P2

1
0
1
(P2 P2 ) ( Q1
D
%Q1

P2
Income D1
10.00 3,000 44.20
50.00 3,000 46.60
0
P2 )
0
Q1 )

(44.2
46.60)
(10

50)

( 10 50)
(44.2 46.60)
(
2.4)
(60)

.0396
(
40) (90.80)

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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
S

%Q
s
%P

S
(Q1

S
Q0 )

( P1 P0 )

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(P1 P0 )
S
( Q1

S
Q0 )

The elasticity of supply

measures movements along the supply curve

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Graphical Analysis

Price

Supply of Shirts
400
375
350
325
300
275
250
225
200
175
150
125
100
75
50
25
0
0

10

20

30

40

50

60

70

80

90

100

Quantity

Supply Data
%Q S
s
%P

S
(Q1

S
Q0 )

( P1 P0 )

(P1 P0 )
S
( Q1

S
Q0 )

(25 20 ) ( 100 80 )

( 100 80 ) ( 25 20 )
( 5 ) (180)

(20) (45)
1

4 1
4
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Q
0
5
10
15
20
25
30
35
40
45
50
55
60

P
0
20
40
60
80
100
120
140
160
180
200
220
240

Another Example of Elasticity of Supply

%Q S
Q
s
%P
50

S
(Q1

S
Q0 )

( P1 P0 )

(P1 P0 )

S
( Q1

P
200
55 220

S
Q0 )

(50 55 )
( 200 220 )

( 200 220 ) ( 50 55 )
( 5 ) (420)

(20) (105)
1

4 1
4
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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.
S

%Q
<1

%P

%Q S

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<

%P

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.

%Q S
> 1

%P

%Q

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>

%P

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.

%Q S
1

%P

%Q

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%P

Classification of the elasticity of supply

Perfectly inelastic - S = 0

vertical

Very short run response

Perfectly elastic - S =

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horizontal

Analysis of an agricultural market

Demand for food and food products is generally price inelastic

%Q D
< 1

%P

%P

> 1
%Q D

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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End of Presentation

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