Question

Explain the cross-price elasticity of demand and income elasticity of demand

Short answer

The concepts of cross price elasticity of demand and income elasticity of demand is explained

Step-by-step solution

Introduction 

The cross elasticity of demand is an economic concept that assesses how responsive the quantity desired of one commodity is to changes in the price of another good.

The income elasticity of demand is an economic measure of how responsive a good or service's quantity demand is to changes in income.

Cross price elasticity of demand

A variation in the quantity demanded one commodity might affect the quantity demanded another. If the two commodities are complementary, such as bread and peanut butter, a decrease in the price of one would increase the quantity requested of the other. The cross-price elasticity of demand gives these theories some flesh.

The concept of "cross-price" relates to how the price of one good influences the amount requested from another. The cross-price elasticity of demand is defined as the percentage change in the quantity of good $A$ demanded as a result of a percentage change in the price of good $B$.

$\text{cross-price elasticity of demand}=\frac{\text{percent change in}Qd\text{of}goodA}{\text{percent change in price of}goodB}$

Positive cross-price elasticities of demand exist for replacement goods: if good $A$ is a substitute for good $B$, such as coffee and tea, then a higher price for B will result in more A being consumed. Complement items have negative cross-price elasticities, which means that if good $A$ is a complement to good $B$, such as coffee and sugar, a higher price for $B$ will result in less $A$ being eaten.

Income elasticity of demand

The income elasticity of demand is calculated by dividing the percentage change in quantity demanded by the percentage change in income:

demand elasticity of income$=\frac{\text{percent change in quantity demanded}}{\text{percent change in income}}$

Most of the time, the income elasticity of demand is positive for most products, meaning that as income rises, so does the quantity required. This pattern is so prevalent that these items are referred to as ordinary items. However, a rise in wealth may result in the purchase of fewer things; for example, individuals with a greater income may purchase fewer hamburgers in favor of steak, or those with a higher income may purchase less inexpensive wine and more imported beer.

When the demand elasticity of income is negative, the good is referred to as inferior. The Supply and Demand module presented the ideas of normal and inferior products.

A higher amount of income leads a demand curve for a normal good to shift to the right, indicating that the income elasticity of demand is positive.