qd always responds positively to the change in income. qdqd o y more elastic less elastic
TRANSCRIPT
Qd always responds positively to the change in income.
QdO
Y
More Elastic
Less Elastic
Recap
D
D`
Q
P
Inelastic D D`
Elastic D D``
∆ Y in PQ space
D``
Example
Income (Rs)Quantity Demanded
(units)
10000 100
12000 105
YЄd = ∆ Q ÷ ∆ Y Q Y = 5 ÷ 2000 100 10000 = 0.25
The Good is normal (the sign is positive). But its demand is income inelastic o< | Є | < 1.
Rule: If sign is positive the good is normal and if sign is negative the good is inferior.
Determinants of income elasticity of demand
1. Degree of necessity of good.
2. The rate at which the desire for good is satisfied as
consumption increases
3. The level of income of consumer.
Food Stuff YЄd
M i l k -0.40
E g g s -0.41
M u t t o n -0.21
B r e a d -0.25
B u t t e r -0.04
M a r g a r I n e -0.44
S u g a r -0.54
F r e s h P o t a t o e s -0.48
T e a -0.56
C h e e s e 0.19
B e e f 0.08
C a k e s & B u i s c u i t s 0.02
F r e s h G r e e n V e g e t a b l e s 0.13
F r e s h F r u i t 0.48
F r e s h J u i c e s 0.94
C o f f e e 0.23
E l a s t i c I t y F o r A l l F o o d -0.01
Cross price elasticity of demand
It is defined as the percentage change in quantity demanded of good A divided by the percentage change in the price of another related good B.
Example
Demand for A Price of B
100 10
140 12
PbЄda = ∆ Qa ÷ ∆ Pb
Q a Pb = 40 ÷ 2 100 10 = 2
Goods are substitutes ( sign is positive ) Demand is cross price elastic | є | > 1.
Rule: If a sign is positive the goods are substitutes and if a sign is negative the goods are complements
Example 2
•A Government will wish to know how a change in A Government will wish to know how a change in
domestic prices will affect the demand for imports. domestic prices will affect the demand for imports.
•Rise in price of imports worsening the Balance of Rise in price of imports worsening the Balance of
payments payments
Adjusting to oil price shocks
SHORT RUNSHORT RUN
P
A
P1
Q
P2
Q1Q2
S1
S2
B
D1
O
Adjusting to oil price shocks
Long Run Long Run effect on demandeffect on demand
P
A
P1
Q
P2
S1
S2
B
D1
D2
C DL
O
Adjusting to oil price shocks
P
DP1
Q
P2
S1
S2
Long Run Long Run effect on supplyeffect on supply
D1
B
S3
FE
SL
O
Incidence of tax when the demand is inelastic
• Fixed TaxFixed Tax
P
BP0
Q
P1
Q0Q1
S1
S2
C TAX
D
A
D
X
D
Incidence of tax when the demand is elastic
• Fixed TaxFixed Tax
P
B`P0
Q
P1
Q0Q1
S0
S1
C`
A`
O
X`
D`
D
TAX
Inelastic demand
• Case 1Case 1
P
P1
Q
P2
Q1Q2
S1
S + Tax
O
D
TAX
Elastic demand
• Case 2Case 2
P
P1
Q
P2
Q1Q2
S1
S + Tax
O
D
TAX
Inelastic supply
• Case 3Case 3
P
P1
Q
P2
Q1Q2
SS + Tax
O
D
TAX
Elastic supply
• Case 4Case 4
P
P1
Q
P2
Q1Q2
S
S + Tax
O
D
TAX
Tax on smoking
• Case 1Case 1
P
P1
Q
P2
Q1Q2
S1
S + Tax
O
D
TAX
Tax on environmental pollution
• Case 3Case 3
P
P1
Q
P2
Q1Q2
SS + Tax
O
D
TAX
3 Core rules of elasticity3 Core rules of elasticity
RULE # 1:
1Less than Greater thanInelasticInelastic ElasticElastic
RULE # 2:
Income elasticity+
–
Normal good
Inferior good
RULE # 3:
Cross elasticity –
Complements
+ Substitutes
SummarySummary