Income elasticity of demand. Cross elasticity of demand. Characteristics of goods.

The income elasticity of demand (eQ,I) measures the relationship between income changes and quantity changes.

Normal goods Þ eQ,I > 0

Luxury goods Þ eQ,I > 1

Inferior goods Þ eQ,I < 0

The cross-price elasticity of demand (eQ,P’) measures the relationship between changes in the price of one good and and quantity changes in another .

• Gross substitutes Þ eQ,P’ > 0

• Gross complements Þ eQ,P’ < 0

• Income elasticity of demand measures the relationship between a change in quantity demanded and a change in income. The basic formula for calculating the coefficient of income elasticity is:

• Percentage change in quantity demanded of good X divided by the percentage change in real consumers' income

• Normal Goods

• Normal goods have a positive income elasticity of demand so as income rise more is demand at each price level. We make a distinction between normal necessities and normal luxuries (both have a positive coefficient of income elasticity).

• Necessities have an income elasticity of demand of between 0 and +1. Demand rises with income, but less than proportionately. Often this is because we have a limited need to consume additional quantities of necessary goods as our real living standards rise. The class examples of this would be the demand for fresh vegetables, toothpaste and newspapers. Demand is not very sensitive at all to fluctuations in income in this sense total market demand is relatively stable following changes in the wider economic (business) cycle.

• Luxuries on the other hand are said to have an income elasticity of demand > +1. (Demand rises more than proportionate to a change in income). Luxuries are items we can (and often do) manage to do without during periods of below average income and falling consumer confidence. When incomes are rising strongly and consumers have the confidence to go ahead with “big-ticket” items of spending, so the demand for luxury goods will grow. Conversely in a recession or economic slowdown, these items of discretionary spending might be the first victims of decisions by consumers to rein in their spending and rebuild savings and household financial balance sheets.

• Many luxury goods also deserve the sobriquet of “positional goods”. These are products where the consumer derives satisfaction (and utility) not just from consuming the good or service itself, but also from being seen to be a consumer by others.

• Inferior Goods
Inferior goods have a negative income elasticity of demand. Demand falls as income rises. In a recession the demand for inferior products might actually grow (depending on the severity of any change in income and also the absolute co-efficient of income elasticity of demand). For example if we find that the income elasticity of demand for cigarettes is -0.3, then a 5% fall in the average real incomes of consumers might lead to a 1.5% fall in the total demand for cigarettes

Date: 2015-01-29; view: 1438