Upload
noel-crawford
View
257
Download
1
Tags:
Embed Size (px)
Citation preview
Module 9Module 9Income Elasticity of
Demand and Cross Price Elasticity of Demand
Income Elasticity of Demand and Cross Price
Elasticity of Demand
1
Define the income elasticity of demandincome elasticity of demand and how to calculate it.
2
ObjectivesObjectives
Define the income elasticity of demandincome elasticity of demand and how to calculate it.
Define the cross-price elasticitycross-price elasticity of demand and how to calculate it.
3
ObjectivesObjectives
4
Define the income elasticity of demandDefine the income elasticity of demandand understand how to calculate it.and understand how to calculate it.
Objective 1Objective 1
5
Define the income elasticity of demandDefine the income elasticity of demandand understand how to calculate it.and understand how to calculate it.
The income elasticity of demandincome elasticity of demand (εI ) measures the responsiveness of quantity demanded to changes in consumer income.
Objective 1Objective 1
6
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
An example will help demonstrate what it is that the income elasticity measures. The graph shows what happens to Janet’s demand for coffee when her income changes.
7
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
An example will help demonstrate what it is that the income elasticity measures. The graph shows what happens to Janet’s demand for coffee when her income changes.
Example 1:Example 1: At point “c”,“c”, the price of coffee is $3.00, Janet’s income is $500/week and Janet’s quantity demanded is 5 cups.
8
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
An example will help demonstrate what it is that the income elasticity measures. The graph shows what happens to Janet’s demand for coffee when her income changes.
Example 1:Example 1: At point “c”,“c”, the price of coffee is $3.00, Janet’s income is $500/week and Janet’s quantity demanded is 5 cups.
When her income rises to $700/week, her demand curve shifts right. She is now willing to buy 8 cups, at the same price. This is given by point “w”“w” on the new demand curve Dnew demand curve D11.
9
Note: the price of coffee does not change; income changes and Janet responds to the income change by buying more coffee.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
10
Note: the price of coffee does not change; income changes and Janet responds to the income change by buying more coffee.
Income elasticity is concerned precisely with this: the change from “c” on one demand curve to “w” on another demand curve, holding price constant.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
11
In Example 1, Janet’s quantity demanded increasesincreases when her income increasesincreases.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
12
In Example 1, Janet’s quantity demanded increasesincreases when her income increasesincreases.
To Janet coffee is a normal good.normal good.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
13
In Example 1, Janet’s quantity demanded increasesincreases when her income increasesincreases.
To Janet coffee is a normal good.normal good.
The income elasticity coefficient for a normal good is positive.positive.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
14
Example 2:Example 2: Consider Daria’s demand for coffee.
At point “c”,“c”, the price of coffee is $3.00, Daria’s income is $500/week and Daria’s quantity demanded is 5 cups.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
15
Example 2:Example 2: Consider Daria’s demand for coffee.
At point “c”,“c”, the price of coffee is $3.00, Daria’s income is $500/week and Daria’s quantity demanded is 5 cups.
When her income risesincome rises to $700/week, she buys lessshe buys less at the same price of coffee. Her quantity demanded has now falls to 3 cups, corresponding to point “x”“x” on the new demand curve DD11..
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
16
Daria’s quantity demanded decreasesdecreases when her income increases.increases.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
17
Daria’s quantity demanded decreasesdecreases when her income increases.increases.
To Daria coffee is an inferiorinferior good.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
18
Daria’s quantity demanded decreasesdecreases when her income increases.increases.
To Daria coffee is an inferiorinferior good.
The income elasticity coefficient for an inferior good is negative.negative.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
19
ΔΔ
% Quantity DemandedIncome Elasticity of Demand = % Income
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
The formula for the income elasticity of demand is:
20
ΔΔ
% Quantity DemandedIncome Elasticity of Demand = % Income
If the income elasticity of demand (εI) is positive,positive, εI > 0 the good is a normal goodnormal good.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
The formula for the income elasticity of demand is:
21
ΔΔ
% Quantity DemandedIncome Elasticity of Demand = % Income
If the income elasticity of demand (εI) is positive,positive, εI > 0 the good is a normal goodnormal good.
If the income elasticity of demand (εI) is negativenegative, εI < 0 the good is an inferiorinferior good.
Objective 1….the income elasticity of demandObjective 1….the income elasticity of demand
The formula for the income elasticity of demand is:
22
Example 3:Example 3: Suppose quantity demanded increases by 4% when income rises by 5%. What is the income elasticity of demand for this good? Indicate if the good is normal or inferior.
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
10
23
Example 3:Example 3: Suppose quantity demanded increases by 4% when income rises by 5%. What is the income elasticity of demand for this good? Indicate if the good is normal or inferior.
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
Since the income elasticity is a positive number, the good is a normal good.
10
24
ΔΔ
% Quantity DemandedIncome Elasticity of Demand = % Income
4=5
= 0.8
Example 3:Example 3: Suppose quantity demanded increases by 4% when income rises by 5%. What is the income elasticity of demand for this good? Indicate if the good is normal or inferior.
Solving the ProblemSolving the Problem
Apply the elasticity formula:
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
Since the income elasticity is a positive number, the good is a normal good.
10
25
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
The income elasticity coefficient = 0.8. What does the number 0.8 mean?
26
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
The income elasticity coefficient = 0.8. What does the number 0.8 mean?
Let’s go back to the elasticity formula and rearrange the equation by cross multiplying.
27
The income elasticity formula can be rewritten as:
%∆Quantity Demanded = 0.8 × %∆Income
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
The income elasticity coefficient = 0.8. What does the number 0.8 mean?
Let’s go back to the elasticity formula and rearrange the equation by cross multiplying.
28
The income elasticity formula can be rewritten as:
%∆Quantity Demanded = 0.8 × %∆Income
For every 1% increaseincrease in income, quantity demanded increasesincreases by 0.8%, or for every 10% increase in income, quantity demanded increases by 8%.
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
The income elasticity coefficient = 0.8. What does the number 0.8 mean?
Let’s go back to the elasticity formula and rearrange the equation by cross multiplying.
29
Example 4:Example 4: Suppose when income rises by 10%, quantity demanded decreases by 6%. Calculate the income elasticity of demand for this good. Indicate if the good is normal or inferior.
Objective 1….calculating the income elasticity Objective 1….calculating the income elasticity of demandof demand
30
Example 4:Example 4: Suppose when income rises by 10%, quantity demanded decreases by 6%. Calculate the income elasticity of demand for this good. Indicate if the good is normal or inferior.
The negative coefficient indicates that the good is an inferior good. inferior good.
Objective 1….calculating the income elasticity Objective 1….calculating the income elasticity of demandof demand
31
Example 4:Example 4: Suppose when income rises by 10%, quantity demanded decreases by 6%. Calculate the income elasticity of demand for this good. Indicate if the good is normal or inferior.
Solving the ProblemSolving the Problem
Apply the elasticity formula:
The negative coefficient indicates that the good is an inferior good. inferior good.
Objective 1….calculating the income elasticity Objective 1….calculating the income elasticity of demandof demand
ΔΔ
% Quantity DemandedIncome Elasticity of Demand = % Income
6=10
= 0.6
32
Example 5:Example 5: Suppose at an income level of $30,000, Francesca buys 2 units of good X per month. When her income rises to $50,000, she buys 5 units per month. Calculate the income elasticity of demand for good X and indicate if the good is inferior or normal.
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
33
Example 5:Example 5: Suppose at an income level of $30,000, Francesca buys 2 units of good X per month. When her income rises to $50,000, she buys 5 units per month. Calculate the income elasticity of demand for good X and indicate if the good is inferior or normal.
Objective 1….calculating the income elasticity of Objective 1….calculating the income elasticity of demanddemand
Solving the ProblemSolving the Problem
Essentially, you are given two sets of income-quantity combinations:
“a”: Income0= $30,000, Q0 = 2 and “b”: Income1 = $50,000; Q1 = 5.
Apply these values to the midpoint midpoint formula. formula.
34
Simplify by cancelling the ½ s and the 100s to give:
ΔΔ
Δ
Δ0 1
0 1
× +
=×
+
% Quantity Income Elasticity of Demand = % Income
Quantity 100½(Q Q )
Income 100½(I I )
Objective 1….the average method of calculating the Objective 1….the average method of calculating the income elasticity of demandincome elasticity of demand
35
Simplify by cancelling the ½ s and the 100s to give:
ΔΔ
Δ
Δ0 1
0 1
× +
=×
+
% Quantity Income Elasticity of Demand = % Income
Quantity 100½(Q Q )
Income 100½(I I )
Δ Δ
0 1
0 1
0 1
0 1
0 1
0 1
0 1
0 1
0 1
0 1
Quantity IncomeIncome Elasticity of Demand = ÷
(Q + Q ) (I + I )
(Q - Q ) (I - I )=
(Q + Q ) (I + I )
Q - Q I + I= ×
Q + Q I - I
Objective 1….the average method of calculating the Objective 1….the average method of calculating the income elasticity of demandincome elasticity of demand
36
Now plug in the given values:
0 1
0 1
0 1
0 1
Q - Q I + IIncome Elasticity of Demand = ×
Q + Q I - I
2 - 5 30,000 + 50,000= ×
2 + 5 30,000 - 50,000
-3 80,000= ×
7 -20,000
3 8= ×
7 2= 1.71
Objective 1….the average method of calculating the Objective 1….the average method of calculating the income elasticity of demandincome elasticity of demand
37
Now plug in the given values:
The income elasticity is positive. Therefore, good X is a normal normal good.
0 1
0 1
0 1
0 1
Q - Q I + IIncome Elasticity of Demand = ×
Q + Q I - I
2 - 5 30,000 + 50,000= ×
2 + 5 30,000 - 50,000
-3 80,000= ×
7 -20,000
3 8= ×
7 2= 1.71
Objective 1….the average method of calculating the Objective 1….the average method of calculating the income elasticity of demandincome elasticity of demand
39
If the income elasticity of demand > 1 demand is income elastic.income elastic.
Objective 1: …describing income elasticitiesObjective 1: …describing income elasticities
40
If the income elasticity of demand > 1 demand is income elastic.income elastic.
If the income elasticity of demand < 1 demand is Income Income
inelastic.inelastic.
Objective 1: …describing income elasticitiesObjective 1: …describing income elasticities
41
If the income elasticity of demand > 1 demand is income elastic.income elastic.
If the income elasticity of demand < 1 demand is Income Income
inelastic.inelastic.
If the income elasticity of demand = 1 demand is unit income unit income
elastic.elastic.
Objective 1: …describing income elasticitiesObjective 1: …describing income elasticities
42
Since inferiorinferior goods have a negative income elasticity (<0) which also means a number < 1, inferior goods are income income inelastic ALWAYS.inelastic ALWAYS.
Objective 1: …describing income elasticitiesObjective 1: …describing income elasticities
43
Since inferiorinferior goods have a negative income elasticity (<0) which also means a number < 1, inferior goods are income income inelastic ALWAYS.inelastic ALWAYS.
NormalNormal goods may be income elastic or income inelastic.
Objective 1: …describing income elasticitiesObjective 1: …describing income elasticities
44
Since inferiorinferior goods have a negative income elasticity (<0) which also means a number < 1, inferior goods are income income inelastic ALWAYS.inelastic ALWAYS.
NormalNormal goods may be income elastic or income inelastic.
NecessitiesNecessities are normal goods that are income inelastic.The income elasticity is a positive number less than 1positive number less than 1.
Objective 1: …describing income elasticitiesObjective 1: …describing income elasticities
45
Since inferiorinferior goods have a negative income elasticity (<0) which also means a number < 1, inferior goods are income income inelastic ALWAYS.inelastic ALWAYS.
NormalNormal goods may be income elastic or income inelastic.
NecessitiesNecessities are normal goods that are income inelastic.The income elasticity is a positive number less than 1positive number less than 1.
Luxury goodsLuxury goods are normal goods that are income elasticThe income elasticity is a positive number greater than 1.positive number greater than 1.
Objective 1: …describing income elasticitiesObjective 1: …describing income elasticities
46
Income elasticity of demand > 1> 1 Normal, luxury good Income elasticelastic
Objective 1: Income elasticity – a summaryObjective 1: Income elasticity – a summary
47
Income elasticity of demand > 1> 1 Normal, luxury good Income elasticelastic
Income elasticity of demand is a positive number less than 1.positive number less than 1.
Normal, necessity Income inelasticinelastic
Objective 1: Income elasticity – a summaryObjective 1: Income elasticity – a summary
48
Income elasticity of demand > 1> 1 Normal, luxury good Income elasticelastic
Income elasticity of demand is a positive number less than 1.positive number less than 1.
Normal, necessity Income inelasticinelastic
Income elasticity = 1= 1 Normal UnitUnit income elastic
Objective 1: Income elasticity – a summaryObjective 1: Income elasticity – a summary
49
Income elasticity of demand > 1> 1 Normal, luxury good Income elasticelastic
Income elasticity of demand is a positive number less than 1.positive number less than 1.
Normal, necessity Income inelasticinelastic
Income elasticity = 1= 1 Normal UnitUnit income elastic
Income elasticity of demand is a a negative number.negative number. Inferior good Income inelasticinelastic
Objective 1: Income elasticity – a summaryObjective 1: Income elasticity – a summary
50
The income elasticity of demandincome elasticity of demand tells us how quantity demanded responds to changes in income.
Objective 1: Income elasticity – a summaryObjective 1: Income elasticity – a summary
51
The income elasticity of demandincome elasticity of demand tells us how quantity demanded responds to changes in income.
The income elasticity of demand is used to determine if a good is an inferiorinferior good or a normalnormal good and, if it is a normal good, whether it is it luxury luxury good or a necessitynecessity.
Objective 1: Income elasticity – a summaryObjective 1: Income elasticity – a summary
52
The cross price elasticity of demandcross price elasticity of demand (CPE) measures the responsiveness of quantity demanded to changes in the price of a substitutesubstitute good or a complementarycomplementary good, holding all else constant.
Define the cross-price elasticity of demand ….Define the cross-price elasticity of demand ….
Objective 2Objective 2
53
The cross price elasticity of demandcross price elasticity of demand (CPE) measures the responsiveness of quantity demanded to changes in the price of a substitutesubstitute good or a complementarycomplementary good, holding all else constant.
For example, if the price of coke changes, how does this affect the quantity demanded of Pepsi, holding the price of Pepsi constant?
Define the cross-price elasticity of demand ….Define the cross-price elasticity of demand ….
Objective 2Objective 2
54
The cross price elasticity of demandcross price elasticity of demand (CPE) measures the responsiveness of quantity demanded to changes in the price of a substitutesubstitute good or a complementarycomplementary good, holding all else constant.
For example, if the price of coke changes, how does this affect the quantity demanded of Pepsi, holding the price of Pepsi constant?
Or, if the price of bagels changes, how does this affect the quantity demanded of cream cheese, holding the price of cream cheese constant?
Define the cross-price elasticity of demand ….Define the cross-price elasticity of demand ….
Objective 2Objective 2
55
Example 1:Example 1: Consider two goods, good X and good Y. Suppose the price of good X rises from $6 to $7.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
An example will help demonstrate what it is that the cross-price elasticity measures.
56
Example 1:Example 1: Consider two goods, good X and good Y. Suppose the price of good X rises from $6 to $7.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
An example will help demonstrate what it is that the cross-price elasticity measures.
The increase is the price of good X is demonstrated by a movementmovement along the demand curve for good X.
When price rises, there is a movement along the curve
57
As a result of the increase in the price of good Xprice of good X, the demand for good Y increasesgood Y increases.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
58
As a result of the increase in the price of good Xprice of good X, the demand for good Y increasesgood Y increases.
At a given price of good Y, the quantity demandedquantity demanded increasesincreases from QQee
to QQff..
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
59
Note: the price of goodprice of good YY does not not change; the price of good X has changed and the consumer responds to this change by buying more of good Y.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
60
Note: the price of goodprice of good YY does not not change; the price of good X has changed and the consumer responds to this change by buying more of good Y.
Cross price elasticity elasticityCross price elasticity elasticity is concerned precisely with this: the change in the price in market X and its effect on the quantity demanded in market Y. In market Y quantity demanded has changed from “e” on one demand curve to “f” on another demand curve, holding the price of good Y constant.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
61
In my example, the increaseincrease in the price of good Xprice of good X causes an increaseincrease in the quantity demanded of good Yquantity demanded of good Y.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
62
In my example, the increaseincrease in the price of good Xprice of good X causes an increaseincrease in the quantity demanded of good Yquantity demanded of good Y.
there is a positive relationshippositive relationship between the change in the price of X and the change in the quantity demanded of Y.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
63
In my example, the increaseincrease in the price of good Xprice of good X causes an increaseincrease in the quantity demanded of good Yquantity demanded of good Y.
there is a positive relationshippositive relationship between the change in the price of X and the change in the quantity demanded of Y.
X and Y are substitute goods.substitute goods.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
64
Example:Example: the cross price elasticity between the price of Coke and the quantity demanded of Pepsi.
Objective 2….understanding the cross-price elasticity of Objective 2….understanding the cross-price elasticity of demanddemand
65
Example:Example: the cross price elasticity between the price of Coke and the quantity demanded of Pepsi.
Suppose Price of Coke ↑Price of Coke ↑
Demand for Pepsi increases (shifts right). At a given price of Pepsi, quantity demanded of Pepsi increases.
Objective 2….understanding the cross-price elasticity of Objective 2….understanding the cross-price elasticity of demanddemand
66
Example:Example: the cross price elasticity between the price of Coke and the quantity demanded of Pepsi.
Suppose Price of Coke ↑Price of Coke ↑
Demand for Pepsi increases (shifts right). At a given price of Pepsi, quantity demanded of Pepsi increases.
positive relationshippositive relationship between the price of Coke and the quantity demanded of Pepsi.
Objective 2….understanding the cross-price elasticity of Objective 2….understanding the cross-price elasticity of demanddemand
67
Example:Example: the cross price elasticity between the price of Coke and the quantity demanded of Pepsi.
Suppose Price of Coke ↑Price of Coke ↑
Demand for Pepsi increases (shifts right). At a given price of Pepsi, quantity demanded of Pepsi increases.
positive relationshippositive relationship between the price of Coke and the quantity demanded of Pepsi.
Coke and Pepsi are substitutes.substitutes.
Objective 2….understanding the cross-price elasticity of Objective 2….understanding the cross-price elasticity of demanddemand
68
Example 2:Example 2: Consider two goods, good A and good B. Suppose the price of good A rises from $5 to $6.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
69
Example 2:Example 2: Consider two goods, good A and good B. Suppose the price of good A rises from $5 to $6.
The increase is the price of good A is demonstrated by a movementmovement along the demand curve for good A.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
When price rises, there is a movement along the curve
70
As a result of the increase in the price of good Aprice of good A, the demand for good B decreasesgood B decreases.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
71
As a result of the increase in the price of good Aprice of good A, the demand for good B decreasesgood B decreases.
At a given price of good Y, the quantity demandedquantity demanded decreasesdecreases from QQgg
to QQhh..
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
72
In this example, the increaseincrease in the price of good A price of good A causes a decreasedecrease in the quantity demanded of good Bquantity demanded of good B.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
73
In this example, the increaseincrease in the price of good A price of good A causes a decreasedecrease in the quantity demanded of good Bquantity demanded of good B.
there is a negative relationshipnegative relationship between the change in the price of good A and the change in the quantity demanded of good B.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
74
In this example, the increaseincrease in the price of good A price of good A causes a decreasedecrease in the quantity demanded of good Bquantity demanded of good B.
there is a negative relationshipnegative relationship between the change in the price of good A and the change in the quantity demanded of good B.
A and B are complementary goods.complementary goods.
Objective 2….the cross-price elasticity of demandObjective 2….the cross-price elasticity of demand
75
Objective 2….understanding the cross-price elasticity of Objective 2….understanding the cross-price elasticity of demanddemand
Example:Example: the cross price elasticity between the price of donuts and the quantity demanded of coffee.
76
Objective 2….understanding the cross-price elasticity of Objective 2….understanding the cross-price elasticity of demanddemand
Example:Example: the cross price elasticity between the price of donuts and the quantity demanded of coffee.
Suppose Price of donuts ↑Price of donuts ↑
demand for coffee decreases (shifts left). At a given price of coffee, quantity demanded of coffee decreases.
77
Objective 2….understanding the cross-price elasticity of Objective 2….understanding the cross-price elasticity of demanddemand
Example:Example: the cross price elasticity between the price of donuts and the quantity demanded of coffee.
Suppose Price of donuts ↑Price of donuts ↑
demand for coffee decreases (shifts left). At a given price of coffee, quantity demanded of coffee decreases.
negative relationshipnegative relationship between the price of donuts and the quantity demanded of coffee.
78
Objective 2….understanding the cross-price elasticity of Objective 2….understanding the cross-price elasticity of demanddemand
Example:Example: the cross price elasticity between the price of donuts and the quantity demanded of coffee.
Suppose Price of donuts ↑Price of donuts ↑
demand for coffee decreases (shifts left). At a given price of coffee, quantity demanded of coffee decreases.
negative relationshipnegative relationship between the price of donuts and the quantity demanded of coffee.
donuts and coffee are complements.complements.
79
The cross price elasticitycross price elasticity of demand between good X and good Y tells us how quantity demand of good Y responds to a change in the price of good X
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary
80
The cross price elasticitycross price elasticity of demand between good X and good Y tells us how quantity demand of good Y responds to a change in the price of good X
The important thing to note is that we are looking at price changes in one marketprice changes in one market and quantity changes in quantity changes in another market.another market.
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary
81
The cross price elasticitycross price elasticity of demand between good X and good Y tells us how quantity demand of good Y responds to a change in the price of good X
The important thing to note is that we are looking at price changes in one marketprice changes in one market and quantity changes in quantity changes in another market.another market.
The signsign of cross price elasticity of demand coefficient indicates if the two goods are substitutessubstitutes or complements.complements.
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary
82
Let CPECPEXYXY denote the cross price elasticity of demand between good X and good Y.
Objective 2…. the cross-price elasticity of demandObjective 2…. the cross-price elasticity of demand
83
ΔΔ
% Quantity Demanded of Good Y= % Price of Good XCPEXY
Let CPECPEXYXY denote the cross price elasticity of demand between good X and good Y.
The formula for the cross price elasticity of demand is:
Objective 2…. the cross-price elasticity of demandObjective 2…. the cross-price elasticity of demand
84
ΔΔ
% Quantity Demanded of Good Y= % Price of Good XCPEXY
Let CPECPEXYXY denote the cross price elasticity of demand between good X and good Y.
The formula for the cross price elasticity of demand is:
If the cross price elasticity of demand is positive,positive, CPEXY > 0 X and Y are substitutes.substitutes.
Objective 2…. the cross-price elasticity of demandObjective 2…. the cross-price elasticity of demand
85
ΔΔ
% Quantity Demanded of Good Y= % Price of Good XCPEXY
Let CPECPEXYXY denote the cross price elasticity of demand between good X and good Y.
The formula for the cross price elasticity of demand is:
If the cross price elasticity of demand is positive,positive, CPEXY > 0 X and Y are substitutes.substitutes.
If the cross price elasticity of demand is negativenegative,CPEXY < 0 X and Y are complements.complements.
Objective 2…. the cross-price elasticity of demandObjective 2…. the cross-price elasticity of demand
86
Example 3:Example 3: Suppose a 6 percent decreasedecrease in the price of ibuprofen causes a 10 percent decrease decrease in the quantity demanded of Tylenol. What is the cross price elasticity of demand for Ibuprofen with respect to the price of Tylenol? Are the two goods complements or substitutes?
Objective 2: calculating the cross-price elasticity Objective 2: calculating the cross-price elasticity of demandof demand
87
Example 3:Example 3: Suppose a 6 percent decreasedecrease in the price of ibuprofen causes a 10 percent decrease decrease in the quantity demanded of Tylenol. What is the cross price elasticity of demand for Ibuprofen with respect to the price of Tylenol? Are the two goods complements or substitutes?
ΔΔ
% Quantity Demanded of Tylenol CPE = % Price of Ibuprofen
-10=-6
=1.67
Objective 2: calculating the cross-price elasticity Objective 2: calculating the cross-price elasticity of demandof demand
Solving the ProblemSolving the Problem
Apply the formula:
88
Example 3:Example 3: Suppose a 6 percent decreasedecrease in the price of ibuprofen causes a 10 percent decrease decrease in the quantity demanded of Tylenol. What is the cross price elasticity of demand for Ibuprofen with respect to the price of Tylenol? Are the two goods complements or substitutes?
ΔΔ
% Quantity Demanded of Tylenol CPE = % Price of Ibuprofen
-10=-6
=1.67
The coefficient is positivepositive which indicates that Tylenol and Ibuprofen are substitutes.substitutes.
Objective 2: calculating the cross-price elasticity Objective 2: calculating the cross-price elasticity of demandof demand
Solving the ProblemSolving the Problem
Apply the formula:
89
How do we interpret the number 1.67≈ 1.7?How do we interpret the number 1.67≈ 1.7?
Objective 2: understanding the cross-price elasticity of Objective 2: understanding the cross-price elasticity of demanddemand
90
How do we interpret the number 1.67≈ 1.7?How do we interpret the number 1.67≈ 1.7?
The cross price elasticity formula can be rewritten as follows:
%∆Quantity Demanded of Tylenol = 1.7 x %∆ Price of Ibuprofen
Objective 2: understanding the cross-price elasticity of Objective 2: understanding the cross-price elasticity of demanddemand
91
How do we interpret the number 1.67≈ 1.7?How do we interpret the number 1.67≈ 1.7?
The cross price elasticity formula can be rewritten as follows:
%∆Quantity Demanded of Tylenol = 1.7 x %∆ Price of Ibuprofen
For every 1% decrease in the price of ibuprofen, the quantity demanded of Tylenol falls by 1.7% or, for every for every 10% increase in the price of ibuprofen, the quantity demanded of Tylenol rises by 17%.
Objective 2: understanding the cross-price elasticity of Objective 2: understanding the cross-price elasticity of demanddemand
92
Example 4:Example 4: In the graph, the demand fordemand for tortilla chipstortilla chips has shifted outward because the price of salsaprice of salsa has fallen from $3.20 to $2.80 per package. Calculate the cross-price elasticity of demand between tortilla chips and salsa. What is the relationship between these two goods?
Objective 2: calculating the cross-price Objective 2: calculating the cross-price elasticity of demandelasticity of demand
93
Solving the problem:Solving the problem:
To calculate the cross-price elasticity of demand between tortilla chips and salsa, we have to calculate(1) the percentage change in the quantity demanded of
tortilla chips
Objective 2: calculating cross-price elasticityObjective 2: calculating cross-price elasticity
The percentage change in the quantity demanded of tortilla chips
94
Solving the problem:Solving the problem:
To calculate the cross-price elasticity of demand between tortilla chips and salsa, we have to calculate(1) the percentage change in the quantity demanded of
tortilla chips(2) the percentage change in the price of salsa
Objective 2: calculating cross-price elasticityObjective 2: calculating cross-price elasticity
The percentage change in the price of salsa
The percentage change in the quantity demanded of tortilla chips
95
Solving the problem:Solving the problem:
To calculate the cross-price elasticity of demand between tortilla chips and salsa, we have to calculate(1) the percentage change in the quantity demanded of
tortilla chips(2) the percentage change in the price of salsa(3) apply the average or midpoint method of calculating
elasticities
Objective 2: calculating cross-price elasticityObjective 2: calculating cross-price elasticity
The percentage change in the price of salsa
The percentage change in the quantity demanded of tortilla chips
96
The average method of calculating cross price elasticity:The average method of calculating cross price elasticity:
c a
0 1
c
%ΔQuantity Demanded of Tortilla ChipsCross Price Elasticity
%ΔPrice of Salsa
ΔQuantity Demanded of Tortilla Chips × 100
½(Q + Q )ΔPrice of Salsa
× 100½(P + P )
ΔQuantity Demanded of Tortilla Chips(Q + Q
=
=
= a
0 1
2,000 -0.4 = ÷
24,000 6
1 6 = - ×
12 0.4
= -1.25
)
ΔPrice of Salsa
(P + P )
97
The average method of calculating cross price elasticity:The average method of calculating cross price elasticity:
c a
0 1
c
%ΔQuantity Demanded of Tortilla ChipsCross Price Elasticity
%ΔPrice of Salsa
ΔQuantity Demanded of Tortilla Chips × 100
½(Q + Q )ΔPrice of Salsa
× 100½(P + P )
ΔQuantity Demanded of Tortilla Chips(Q + Q
=
=
= a
0 1
2,000 -0.4 = ÷
24,000 6
1 6 = - ×
12 0.4
= -1.25
)
ΔPrice of Salsa
(P + P )
The negative coefficient indicates that the two goods are complementscomplements.
98
The cross price elasticitycross price elasticity of demand between good X and good Y tells us how quantity demand of good Y responds to a change in the price of good X
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary
99
The cross price elasticitycross price elasticity of demand between good X and good Y tells us how quantity demand of good Y responds to a change in the price of good X
The important thing to note is that we are looking at price changes in one marketprice changes in one market and quantity changes in quantity changes in another market.another market.
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary
100
The cross price elasticitycross price elasticity of demand between good X and good Y tells us how quantity demand of good Y responds to a change in the price of good X
The important thing to note is that we are looking at price changes in one marketprice changes in one market and quantity changes in quantity changes in another market.another market.
The signsign of cross price elasticity of demand coefficient indicates if the two goods are substitutessubstitutes or complements.complements.
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary
101
Cross price elasticity of demand between X and Y is a positivepositive number. X and Y are substitutessubstitutes
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary
102
Cross price elasticity of demand between X and Y is a positivepositive number. X and Y are substitutessubstitutes
Cross price elasticity of demand between X and Y is a negative negative number. X and Y are complementscomplements
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary
103
Cross price elasticity of demand between X and Y is a positivepositive number. X and Y are substitutessubstitutes
Cross price elasticity of demand between X and Y is a negative negative number. X and Y are complementscomplements
Cross price elasticity of demand between X and Y is zero.zero. X and Y are unrelatedunrelated
Objective 1: Cross Price elasticity – a summaryObjective 1: Cross Price elasticity – a summary