Cross-Price, Income and Supply Elasticities

1. Cross-Price, Income and Supply Elasticities Overheads

2. 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

3. Price and Income Elasticities of Demand Income elasticity measures shifts in the demand curve Price elasticity measures movements along the curve

4. D1, I = 3000 D2, I = 4000 Graphical Analysis Demand for Q 32 30 Price 28 26 24 22 20 18 16 14 12 10 8 6 20 30 40 50 60 70 80 90 100 110 120 Quantity

5. Computing price elasticity (income constant) PriceIncomeDemand 13.00 3000.00 68.75 14.00 3000.00 63.74 20.00 3000.00 44.20 21.00 3000.00 42.03   13.00 4000.00 91.83 14.00 4000.00 85.17 20.00 4000.00 59.20 21.00 4000.00 56.31  

6. Price Elasticity of Demand (Income = 4000) PriceIncome Demand 20.00 4000.00 59.20 21.00 4000.00 56.31

7. Price Elasticity of Demand (Income = 3000) PriceIncome Demand 20.00 3000.00 44.20 21.00 3000.00 42.03  -1.0257

8. PriceIncomeDemand 13.00 3000.00 68.75 14.00 3000.00 63.74 20.00 3000.00 44.20 21.00 3000.00 42.03 13.00 4000.00 91.83 14.00 4000.00 85.17 20.00 4000.00 59.20 21.00 4000.00 56.31 Computing income elasticity (price constant)

9. PriceIncomeDemand 13.00 3000.00 68.75 14.00 3000.00 63.74 20.00 3000.00 44.20 21.00 3000.00 42.03  Q 13.00 4000.00 91.83 14.00 4000.00 85.17 20.00 4000.00 59.20 21.00 4000.00 56.31 Computing income elasticity (price constant)

10. PriceIncomeDemand 13.00 3000.00 68.75 14.00 3000.00 63.74 20.00 3000.0044.20 21.00 3000.00 42.03  Q  I 13.00 4000.00 91.83 14.00 4000.00 85.17 20.00 4000.0059.20 21.00 4000.00 56.31 Demand Data on Q

11. Income Elasticity of Demand PriceIncomeDemand 20.00 3000.00 44.20 20.00 4000.00 59.20

12. Normal and Inferior Goods Normal goods have a positive income elasticity Inferior goods have a negative income elasticity

13. Necessities and Luxuries Necessities typically have an income elasticity between 0 and 1 Luxuries typically have an income elasticity greater than 1

14. Examples Fresh Fruit Meat (Steak) Potatoes Food Transportation (???) Eating out Cigarettes

15. 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

16. We can then rewrite this as

17. 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

18. D1, P2 = 10 D1, P2 = 50 Graphical Analysis Demand for Q1 32 30 Price 28 26 24 22 20 18 16 14 12 10 8 20 30 40 50 60 70 80 90 100 Quantity

19. Demand Data for Alternative Prices of Good 2 P1P2IncomeD1 13.00 10.00 3,000 68.75 14.00 10.00 3,000 63.74 20.00 10.00 3,000 44.20 21.00 10.00 3,000 42.03 13.00 50.00 3,000 72.45 14.00 50.00 3,000 67.17 20.00 50.00 3,000 46.60 21.00 50.00 3,000 44.31 22.00 50.00 3,000 42.24

20. Demand Data for Alternative Prices of Good 2 P1P2IncomeD1 13.00 10.00 3,000 68.75 14.00 10.00 3,000 63.74 20.00 10.00 3,000 44.20 21.00 10.00 3,000 42.03 13.00 50.00 3,000 72.45 14.00 50.00 3,000 67.17 20.00 50.00 3,000 46.60 21.0050.003,000 44.31 22.00 50.00 3,000 42.24

21. Price Elasticity of Demand PriceIncome Demand 20.00 3000.00 44.20 21.00 3000.00 42.03

22. Cross-price elasticity of demand for good 1 as the price of good 2 changes from $10 to $50 P1 P2 Income D1 20.00 10.00 3,000 44.20 20.00 50.00 3,000 46.60

23. 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

24. Substitutes Beef and Pork Rice Chex and Life Cereal Ford and Dodge Cars Margarine and Butter

25. Complements Printers and Printer Paper Cars and Gasoline Food and Entertainment Televisions and VCRs

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27. 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

28. The elasticity of supply measures movements along the supply curve

29. Graphical Analysis Supply of Shirts 400 375 Price 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

30. Supply Data Q P 0 0 5 20 10 40 15 60 20 80 25 100 30 120 35 140 40 160 45 180 50 200 55 220 60 240

31. Another Example of Elasticity of Supply Q P 50 200 55 220

32. 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.

33. 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.

34. 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.

35. 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.

36. Classification of the elasticity of supply Perfectly inelastic - S = 0 vertical Very short run response Perfectly elastic - S =  horizontal

37. Analysis of an agricultural market Demand for food and food products is generally price inelastic 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

39. End of Presentation