Download YED and XPED

Elasticity of Demand
Objectives
• To understand and be able to calculate
income and cross price elasticity of
demand
• Be able to evaluate the business
relevance of these elasticity estimates
Income and Cross Price
Elasticity
Income Elasticity of Demand
Measures the responsiveness of
quantity demanded to changes in income
YED =
% ∆ QD
%∆Y
Normal Goods
•
•
•
•
•
An increase in income will lead to an increase in demand
They have a positive income elasticity
Examples?
Necessities have low YED (0-0.5) WHY?
Superior/ luxury goods have a high YED (greater than
1)
Note: descriptions of elasticity still apply:
0 means demand is perfectly inelastic with respect to a
change in income
2 would indicate demand is elastic with respect to a
change in income and the good is a luxury item
Inferior Goods
• An increase in income will lead to a decrease
in demand
• They have a negative income elasticity
• Egs. Bus transport- consumers switch from
buses to cars when they can afford their own
cars
Other examples?
Quantity
D normal good
D good- normal at
low levels of income
and inferior at
higher levels of
income
D inferior good
Income
Question
Calculate the Income elasticity of demand. Comment
on the type of good
£
Original
New
Q Demanded Income
Q Demanded Income
100
15
50
12
200
25
120
20
40
15
250
30
10
6
25
100
10
20
14
7
35
125
11
18
• A consumer had an increase in her income from
£80000 to £100000 p.a. In the following year,
her expenditure on holidays increased from
£8000 to £10000, her expenditure on gym
member ship remained the same and her
expenditure on locally produced clothing fell
from £2000 to £1500
1. Calculate her YED for holidays and explain what
this means
2. Calculate her YED for gym membership and
explain what this means
3. Calculate her YED for locally produced clothes
and explain what this means
Business Significance?
• When the economy is doing well, and
incomes are rising, what products will do
well?
• Think of other situations...
Cross Price Elasticity of
Demand
• Measures the responsiveness of the
quantity demanded of one good to
changes in the price of another
• Complements eg. Bread and butter
• Substitutes eg. Beef and chicken
% ∆ QD of good X
% ∆ P of good Y
Note: a figure of 0
indicates no relationship
Goods which are
Substitutes
Goods which are
Complements
As the price of one
good rises, the
demand for
substitute good
_____________
As the price of one
good rises, the
demand for the
complement good
_______________
Type of XPED
(positive or
negative?)
Explanation
Positive or Negative XED?
Gas and electricity
Tennis shorts and tennis rackets
Luxury cars and petrol
Cold Storage own baked beans and
Tescos own baked beans
• Pepsi and Coca Cola
•
•
•
•
• “Light- Bites” a sandwich shop finds that when
it’s rival “Super-Snack” reduces the price of it’s
chicken wraps from £5 to £4.60, the demand
for “Light- Bites” sandwiches falls from 400 to
340 sandwiches a week. In addition, “SuperSnack” finds that following the fall in the price
of their chicken wraps, the demand for soft
drinks rises from 600 cans to 630 cans per week
1. Calculate the XED between “Light- Bites”
sandwiches and “Super- Snack” sandwiches.
Explain the relationship..
2. Calculate the XED between “Super-Snack”
sandwiches and drinks. Explain the relationship
Business Significance?
• Firms need to be aware of the XPED for the products
they sell hence aware of the possible impact a close
competitor may have when they change the price of
their product and vice versa
• Also, firms selling complementary or substitute
products need to be aware of the effects that any
price change for a good has on the demand for the
related products it sells
• Eg. If a café put the price of coffee up it would be
able to estimate the impact that would have on the
demand for chocolate cake
Quick Calculations
• Calculate the percentage change in demand in
each of the following cases:
• Yed is 2.4 and the % Δ Y is 5%
• Xed is -1.5 and the % Δ Price of good y is
20%
• Ped is -0.6 and the % Δ P is 18%
• Yed is - 3.1 and the % Δ Y is 8%
• Where appropriate say whether the good is a
normal good or an inferior good, or whether it
is a substitute or complement.