- Income elasticity of demand
- The income elasticity of demand is the percentage change in quantity demanded divided by the percentage change in income.
- Cross-price elasticity of demand
- The cross-price elasticity of demand is the percentage change in the quantity of good A demanded divided by the percentage change in the price of good B.
Types of good by income and cross elasticity
Can you name the five types of good you can label from income and cross elasticity?
The first three are read from the income elasticity, the last two from the cross elasticity.
A normal good is one for which the quantity demanded rises as income rises and falls as income falls, so its income elasticity is positive.
Can you think of an example?
Incomes rise 10 per cent and the number of new cars bought rises 5 per cent: an income elasticity of +0.5, positive, so new cars are a normal good.
An inferior good is one for which the quantity demanded falls as income rises and rises as income falls, so its income elasticity is negative.
Can you think of an example?
Incomes rise 10 per cent and local bus journeys fall 4 per cent, an income elasticity of −0.4, as people who can now run a car stop taking the bus.
A luxury good is a normal good whose income elasticity is greater than one, so the quantity demanded rises proportionally faster than income.
Can you think of an example?
Incomes rise 10 per cent and foreign holidays taken rise 15 per cent: an income elasticity of +1.5, above one, so holidays are a luxury.
Substitutes are goods that can replace each other to some extent, so a higher price for one raises the quantity demanded of the other and the cross elasticity is positive.
Can you think of an example?
The price of tea rises 10 per cent and the quantity of coffee demanded rises 6 per cent as some tea drinkers switch: a cross elasticity of +0.6.
Complements are goods often used together, so a higher price for one lowers the quantity demanded of the other and the cross elasticity is negative.
Can you think of an example?
Printers rise 20 per cent in price and ink sales fall 10 per cent, a cross elasticity of −0.5, because fewer new printers means less ink bought.