For estimating demand for a product/services, which do you

think is important? (a)Is it price elasticity? (b) Income

elasticity, (c) or is it cross elasticity? Give example to prove
your point.

SUBMITTED TO SUBMITTED BY

SAKTHI SRINIVASAN K NAME : SARAN.G

PROFESSOR REG.NO: 19BBA0035

VIT BUSINESS SCHOOL SLOT : B2+TB2

VELLORE.INST.OF TECHNOLOGY DATE : 16/09/2019

VELLORE SUBJECT: INTRODUCTION TO

ECONOMICS
Which Factors Are Important in
Determining the Demand Elasticity of a
Good?
Demand elasticity measures how sensitive the quantity
demanded of a good or service is to changes in other variables.
Many factors are important in determining the demand elasticity of
a good or service, such as the price level, type of good or service,
availability of a substitute, and level of consumer income.

The price level affects the demand for a good or service. The
price elasticity of demand can be used to measure the sensitivity
of a change in the quantity demanded of a good or service
relative to a change in its price. The price elasticity of demand is
calculated by dividing the percent change in the quantity
demanded of a good or service by its percent change in its price
level. A change in the price level of a good or service determines
the elasticity of the good.

For example, luxury goods have a high elasticity of demand

because they are sensitive to price changes. Suppose the prices
of LED televisions decrease in price by 50%. The demand
increases, because they are more affordable to those who were
unable to purchase them before.

The type of good or service also affects the elasticity of demand.

A good or service may be a luxury, a necessity, or a comfort to a
consumer. When a good or service is a luxury or a comfort good,
it is highly elastic when compared to a necessary good. An
essential good, such as food, is generally inelastic because
consumers still buy food even if the price changes.

The availability of substitute goods affects the demand elasticity

of goods or services. Hence, the demand for goods or services
with many substitutes is highly elastic. A small increase in the
price levels of goods causes consumers to buy its substitutes.
When close substitutes are available, the quantity demanded is
highly sensitive to changes in the price level and vice versa. The
demand elasticity of goods with close substitutes is measured by
dividing the percent change of the quantity demanded of one
product by the percent change in the price of a substitute product.
This formula is also known as the cross elasticity of demand.

For example, demand for soda is highly elastic because of a large

number of substitutes. If the price of one soda rises, consumers
opt to buy the cheaper substitute.

The level of consumer income plays a role in the demand

elasticity of goods and services. The income elasticity of
demand is used to measure the sensitivity of a change in the
quantity demanded relative to a change in consumers' incomes.
Different types of goods are affected by income levels. For
example, inferior goods, such as generic products, have a
negative income elasticity of demand. The quantity demanded for
generic products tends to fall as consumers' incomes increase.

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Income Elasticity of demand

Income elasticity of demand refers to the sensitivity of the quantity

demanded for a certain good to a change in real income of
consumers who buy this good, keeping all other things constant.
The formula for calculating income elasticity of demand is the
percent change in quantity demanded divided by the percent
change in income. With income elasticity of demand, you can tell
if a particular good represents a necessity or a luxury.

Breaking Down Income Elasticity of Demand

Income elasticity of demand measures the responsiveness
of demand for a particular good to changes in consumer
income. The higher the income elasticity of demand in
absolute terms for a particular good, the bigger
consumers' response in their purchasing habits — if their
real income changes. Businesses typically evaluate
income elasticity of demand for their products to help
predict the impact of a business cycle on product sales.
Calculation of Income Elasticity of Demand
Consider a local car dealership that gathers data on
changes in demand and consumer income for its cars for
a particular year. When the average real income of its
customers falls from $50,000 to $40,000, the demand for
its cars plummets from 10,000 to 5,000 units sold, all other
things unchanged. The income elasticity of demand is
calculated by taking a negative 50% change in demand, a
drop of 5,000 divided by the initial demand of 10,000 cars,
and dividing it by a 20% change in real income — the
$10,000 change in income divided by the initial value of
$50,000. This produces an elasticity of 2.5, which
indicates local customers are particularly sensitive to
changes in their income when it comes to buying cars.
Interpretation of Income Elasticity of Demand
Depending on the values of the income elasticity of
demand, goods can be broadly categorized as inferior
goods and normal goods. Normal goods have a positive
income elasticity of demand; as incomes rise, more goods
are demanded at each price level. Normal goods whose
income elasticity of demand is between zero and one are
typically referred to as necessity goods, which are
products and services that consumers will buy regardless
of changes in their income levels. Examples of necessity
goods and services include tobacco products, haircuts,
water and electricity. As income rises, the proportion of
total consumer expenditures on necessity goods typically
declines. Inferior goods have a negative income elasticity
of demand; as consumers' income rises, they buy fewer
inferior goods. A typical example of such type of product is
margarine, which is much cheaper than butter.
Luxury goods represent normal goods associated with
income elasticities of demand greater than one.
Consumers will buy proportionately more of a particular
good compared to a percentage change in their income.
Consumer discretionary products such as premium cars,
boats and jewelry represent luxury products that tend to
be very sensitive to changes in consumer income. When a
business cycle turns downward, demand for consumer
discretionary goods tends to drop as workers become
unemployed.
Basically, a negative income elasticity of demand is linked
with inferior goods, meaning rising incomes will lead to a
drop in demand and may mean changes to luxury goods.
A positive income elasticity of demand is linked with
normal goods. In this case, a rise in income will lead to a
rise in demand.
Types of Income Elasticity of Demand
1. Positive income elasticity of demand (EY>0)
If there is direct relationship between income of the consumer
and demand for the commodity, then income elasticity will be
positive. That is, if the quantity demanded for a commodity
increases with the rise in income of the consumer and vice versa,
it is said to be positive income elasticity of demand. For
example: as the income of consumer increases, they consume
more of superior (luxurious) goods. On the contrary, as the
income of consumer decreases, they consume less of luxurious
goods.

Cite this article as: Shraddha Bajracharya, "Income Elasticity of

Demand: Definition and Types with Examples,"

Positive income elasticity can be further classified into three
types:
  Income elasticity greater than unity (EY > 1)
If the percentage change in quantity demanded for a commodity
is greater than percentage change in income of the consumer, it
is said to be income greater than unity. For example: When the
consumer’s income rises by 3% and the demand rises by 7%, it
is the case of income elasticity greater than unity.

In the given figure, quantity demanded and consumer’s income

is measured along X-axis and Y-axis respectively. The small rise
in income from OY to OY1 has caused greater rise in the
quantity demanded from OQ to OQ1 and vice versa. Thus, the
demand curve DD shows income elasticity greater than unity.
 Income elasticity equal to unity (EY = 1)

If the percentage change in quantity demanded for a commodity

is equal to percentage change in income of the consumer, it is
said to be income elasticity equal to unity. For example: When
the consumer’s income rises by 5% and the demand rises by 5%,
it is the case of income elasticity equal to unity.

In the given figure, quantity demanded and consumer’s income

is measured along X-axis and Y-axis respectively. The small rise
in income from OY to OY1 has caused equal rise in the quantity
demanded from OQ to OQ1 and vice versa. Thus, the demand
curve DD shows income elasticity equal to unity.
 Income elasticity less than unity (EY < 1)

If the percentage change in quantity demanded for a commodity

is less than percentage change in income of the consumer, it is
said to be income greater than unity. For example: When the
consumer’s income rises by 5% and the demand rises by 3%, it
is the case of income elasticity less than unity.
In the given figure, quantity demanded and consumer’s income
is measured along X-axis and Y-axis respectively. The greater
rise in income from OY to OY1 has caused small rise in the
quantity demanded from OQ to OQ1 and vice versa. Thus, the
demand curve DD shows income elasticity less than unity.
2. Negative income elasticity of demand ( EY<0)
If there is inverse relationship between income of the consumer
and demand for the commodity, then income elasticity will be
negative. That is, if the quantity demanded for a commodity
decreases with the rise in income of the consumer and vice
versa, it is said to be negative income elasticity of demand. For
example:
As the income of consumer increases, they either stop or
consume less of inferior goods.
In the given figure, quantity demanded and consumer’s income
is measured along X-axis and Y-axis respectively. When the
consumer’s income rises from OY to OY1 the quantity
demanded of inferior goods falls from OQ to OQ1 and vice
versa. Thus, the demand curve DD shows negative income
elasticity of demand.
3. Zero income elasticity of demand ( EY=0)
If the quantity demanded for a commodity remains constant with
any rise or fall in income of the consumer and, it is said to be
zero income elasticity of demand. For example: In case of basic
necessary goods such as salt, kerosene, electricity, etc. there is
zero income elasticity of demand.
In the given figure, quantity demanded and consumer’s income
is measured along X-axis and Y-axis respectively. The
consumer’s income may fall to OY1 or rise to OY2 from OY, the
quantity demanded remains the same at OQ. Thus, the demand
curve DD, which is vertical straight line parallel to Y-axis shows
zero income elasticity of demand.
Cross Elasticity of Demand
The cross elasticity of demand is an economic concept
that measures the responsiveness in the quantity
demanded of one good when the price for another good
changes. Also called cross-price elasticity of demand, this
measurement is calculated by taking the percentage
change in the quantity demanded of one good and dividing
it by the percentage change in the price of the other good.
Explaining Cross Elasticity of Demand
Substitute Goods
The cross elasticity of demand for substitute goods is
always positive because the demand for one good
increases when the price for the substitute good
increases. For example, if the price of coffee increases,
the quantity demanded for tea (a substitute beverage)
increases as consumers switch to a less expensive yet
substitutable alternative. This is reflected in the cross
elasticity of demand formula, as both the numerator
(percentage change in the demand of tea) and
denominator (the price of coffee) show positive increases.
Items with a coefficient of 0 are unrelated items and are
goods independent of each other. Items may be weak
substitutes, in which the two products have a positive but
low cross elasticity of demand. This is often the case for
different product substitutes, such as tea versus coffee.
Items that are strong substitutes have a higher cross-
elasticity of demand. Consider different brands of tea; a
price increase in one company’s green tea has a higher
impact on another company’s green tea demand.
Complementary Goods
Alternatively, the cross elasticity of demand
for complementary goods is negative. As the price for one
item increases, an item closely associated with that item
and necessary for its consumption decreases because the
demand for the main good has also dropped.
For example, if the price of coffee increases, the quantity
demanded for coffee stir sticks drops as consumers are
drinking less coffee and need to purchase fewer sticks. In
the formula, the numerator (quantity demanded of stir
sticks) is negative and the denominator (the price of
coffee) is positive. This results in a negative cross
elasticity.
Companies utilize cross-elasticity of demand to establish
prices to sell their goods. Products with no substitutes
have the ability to be sold at higher prices because there
is no cross-elasticity of demand to consider. However,
incremental price changes to goods with substitutes are
analyzed to determine the appropriate level of demand
desired and the associated price of the good.
Additionally, complementary goods are strategically priced
based on cross-elasticity of demand. For example, printers
may be sold at a loss with the understanding that the
demand for future complementary goods, such as printer
ink, should increase.
Cross Elasticity of Demand – Briefly
Described (with diagram)

Very often demand for two goods are so related to each

other that when the price of any of them changes, the

demand for the other goods changes, when its own price

remains the same. Therefore, the change in the demand

for one goods in response to the change in price of another

goods represents the cross elasticity of demand of one

goods for the other.

The concept of cross elasticity of demand is illustrated in

Figure 23 where demand curves of two goods X and Y are

given. Initially, the price of goods Y is OP1, at which OQ,

quantity of it is demanded and the price of goods X is OF

at which OM, quantity of it is demanded.

Now suppose that the price of goods Y falls from OP1 to

OP, while price of goods X remains constant at OP. As a

consequence of the fall in price of goods Y from OP, to OP,

its quantity demanded rises from OQ to OQ. In drawing

the demand curve Dz Dx for goods X, it is assumed that the

price of other goods (including goods y) remains the same.

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Now that the price of goods y has fallen and as a result its

quantity demanded has increased, it will have an effect on

the demand for goods X. If goods Y is a substitute for

goods X, then as a result of the fall in price of goods Y from

Op1 to OP, the demand curve of goods X will shift to the

left, that is the demands for goods X will decrease.

As the quantity of a goods increases, the marginal utility of

its substitute goods declines and, therefore, the entire

marginal utility curve of the substitute goods shifts to the

left. As shall be seen from the Figure 24 that as a result of

the fall in price of goods Y, the demand curve of goods X

shifts from D, D, to the dotted position D’, D’, so that at

price OP now less quantity OM, of x is demanded. M, M, of

good X has been substituted by O, Q, of goods Y.

It should be noted that if goods X instead of being

substitute is complement of goods Y, then the fall in price

of goods and resultant increase in its quantity demanded

would have caused the increase in the demand for goods X

and as a result the entire demand curve, instead of shifting

to the left, would have shifted to the right.

price Elasticity of Demand
Price elasticity of demand is an economic measure of the
change in the quantity demanded or purchased of a
product in relation to its price change. Expressed
mathematically, it is:

Price Elasticity of Demand = % Change in

Quantity Demanded / % Change in Price
Price elasticity is used by economists to understand how
supply or demand changes given changes in price to
understand the workings of the real economy. For
instance, some goods are very inelastic, that is, their
prices do not change very much given changes in supply
or demand, for example people need to buy gasoline to
get to work or travel around the world, and so if oil prices
rise, people will likely still buy just the same amount of
gas. On the other hand, certain goods are very elastic,
their price moves cause substantial changes in its demand
or its supply. (Arc elasticity is the elasticity of one variable
with respect to another between two given points.) Here,
we will look just at how the demand side of the equation is
impacted by fluctuations in price by considering the price
elasticity of demand – which you can contrast with price
elasticity of supply.
If the quantity demanded of a product exhibits a large
change in response to changes in its price, it is termed
"elastic," that is, quantity stretched far from its prior point.
If the quantity purchased has a small change in response
to its price, it is termed "inelastic"; or quantity didn't stretch
much from its prior point.
The more easily a shopper can substitute one product with
a rising price for another, the more the price will fall – be
"elastic." In other words, in a world where people equally
like coffee and tea, if the price of coffee goes up, people
will have no problem switching to tea, and so the demand
for coffee will fall. This is because coffee and tea are
considered good substitutes to each other.
The more discretionary a purchase is, the more its
quantity will fall in response to price rises, that is, the
higher the elasticity. So, if you are considering buying a
new washing machine but the current one still works (it's
just old and outdated), and if the prices of new washing
machines goes up, you're likely to forgo that immediate
purchase and wait either until prices go down or until the
current machine breaks down.
On the other hand, the less discretionary a good is, the
less its quantity demanded will fall. Inelastic examples
include luxury items where shoppers "pay for the
privilege" of buying a brand name, addictive products, and
required add-on products. Addictive products may include
tobacco and alcohol. Sin taxes on these types of products
are possible to introduce because the lost tax
revenue from fewer units sold is exceeded by the higher
taxes on units still sold. Examples of add-on products are
ink-jet printer cartridges or college textbooks. These items
are usually more necessary (as opposed to discretionary)
and lack good substitutes (only HP ink will work in HP
printers).
Time also matters. Demand response to price fluctuations
is different for a one-day sale than for a price change over
a season or year. Clarity in time sensitivity is vital to
understanding the price elasticity of demand and for
comparing it across different products.
Examples of Price Elasticity of Demand
Generally as rules of thumb, if the quantity of a good
demanded or purchased changes more than the price
change, the product is termed elastic. (The price changes
by +5%, but the demand falls by -10%). If the change in
quantity purchased is the same as the price change (say,
10%/10% = 1), the product is said to have unit (or unitary)
price elasticity. Finally, if the quantity purchased changes
less than the price (say, -5% demanded for a +10%
change in price), then the product is termed inelastic.
To calculate the elasticity of demand, let's take a very
simple example: Suppose that the price of apples falls by
6% from $1.99 a bushel to $1.87 a bushel. In response,
grocery shoppers increase their apple purchases by 20%.
The elasticity of apples would thus be: 0.20/0.06 = 3.33
indicating that apples are quite elastic in terms of their
demand.
 Types of Price Elasticity of Demand
1. Perfectly Elastic Demand:
When a small change in price of a product causes a major
change in its demand, it is said to be perfectly elastic
demand. In perfectly elastic demand, a small rise in price
results in fall in demand to zero, while a small fall in price
causes increase in demand to infinity. In such a case, the
demand is perfectly elastic or ep = 00.
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The degree of elasticity of demand helps in defining the
shape and slope of a demand curve. Therefore, the
elasticity of demand can be determined by the slope of the
demand curve. Flatter the slope of the demand curve,
higher the elasticity of demand.
In perfectly elastic demand, the demand curve is
represented as a horizontal straight line, which is
shown in Figure-2:
From Figure-2 it can be interpreted that at price OP,
demand is infinite; however, a slight rise in price would
result in fall in demand to zero. It can also be interpreted
from Figure-2 that at price P consumers are ready to buy
as much quantity of the product as they want. However, a
small rise in price would resist consumers to buy the
product.
Though, perfectly elastic demand is a theoretical concept
and cannot be applied in the real situation. However, it
can be applied in cases, such as perfectly competitive
market and homogeneity products. In such cases, the
demand for a product of an organization is assumed to be
perfectly elastic.
From an organization’s point of view, in a perfectly elastic
demand situation, the organization can sell as much as
much as it wants as consumers are ready to purchase a
large quantity of product. However, a slight increase in
price would stop the demand.
2. Perfectly Inelastic Demand:
A perfectly inelastic demand is one when there is no
change produced in the demand of a product with change
in its price. The numerical value for perfectly inelastic
demand is zero (ep=0).
In case of perfectly inelastic demand, demand
curve is represented as a straight vertical line,
which is shown in Figure-3:
It can be interpreted from Figure-3 that the movement in
price from OP1 to OP2 and OP2 to OP3 does not show any
change in the demand of a product (OQ). The demand
remains constant for any value of price. Perfectly inelastic
demand is a theoretical concept and cannot be applied in a
practical situation. However, in case of essential goods,
such as salt, the demand does not change with change in
price. Therefore, the demand for essential goods is
perfectly inelastic.
3. Relatively Elastic Demand:
Relatively elastic demand refers to the demand when the
proportionate change produced in demand is greater than
the proportionate change in price of a product. The
numerical value of relatively elastic demand ranges
between one to infinity.
Mathematically, relatively elastic demand is known as
more than unit elastic demand (ep>1). For example, if the
price of a product increases by 20% and the demand of the
product decreases by 25%, then the demand would be
relatively elastic.
The demand curve of relatively elastic demand is
gradually sloping, as shown in Figure-4:

It
can
be
interpreted from Figure-4 that the proportionate change in
demand from OQ1 to OQ2 is relatively larger than the
proportionate change in price from OP1 to OP2. Relatively
elastic demand has a practical application as demand for
many of products respond in the same manner with
respect to change in their prices.
For example, the price of a particular brand of cold drink
increases from Rs. 15 to Rs. 20. In such a case, consumers
may switch to another brand of cold drink. However, some
of the consumers still consume the same brand. Therefore,
a small change in price produces a larger change in
demand of the product.
4. Relatively Inelastic Demand:
Relatively inelastic demand is one when the percentage
change produced in demand is less than the percentage
change in the price of a product. For example, if the price
of a product increases by 30% and the demand for the
product decreases only by 10%, then the demand would be
called relatively inelastic. The numerical value of relatively
elastic demand ranges between zero to one (ep<1).
Marshall has termed relatively inelastic demand as
elasticity being less than unity.
The demand curve of relatively inelastic demand
is rapidly sloping, as shown in Figure-5:

It can be interpreted from Figure-5 that the proportionate

change in demand from OQ1 to OQ2 is relatively smaller
than the proportionate change in price from OP1 to OP2.
Relatively inelastic demand has a practical application as
demand for many of products respond in the same manner
with respect to change in their prices.
5. Unitary Elastic Demand:
When the proportionate change in demand produces the
same change in the price of the product, the demand is
referred as unitary elastic demand. The numerical value
for unitary elastic demand is equal to one (ep=1).
The demand curve for unitary elastic demand is
represented as a rectangular hyperbola, as shown
in Figure-6:

From Figure-6, it can be interpreted that change in price

OP1 to OP2 produces the same change in demand from
OQ1 to OQ2. Therefore, the demand is unitary elastic.