Income and Cross Elasticity of Demand

INCOME ELASTICITY OF DEMAND (Ey)

Income of the consumer is the most influencing factor of demand for a good. Demand for goods responses to the change in income of the buyer. The measure of the responsiveness of quantity demands a product to change in income of the buyer, being other things constant is known as income elasticity of demand. It is always expressed in term of ratio or percentage. The value of it may be positive, negative or zero depending on the nature of goods. Income elasticity is usually symbolized by 'Ey' and written as:

Ey = percentage change in quantity demand / percentage change in income of the consumer

= (ΔQ / ΔY) * (Y / Q)

Where,

Ey = Income elasticity demand

ΔY= Change in consumer income

ΔQ= Change in quantity

Q = Quantity

Y = Income

DEGREE / TYPES OF INCOME ELASTICITY OF DEMAND

There are three types of income elasticity of demand. They are as follow:

i) Zero Income Elasticity of Demand (Ey=0)

If the quantity demand for a good is totally irresponsive to the change in income of a consumer, then the demand is known as zero income elasticity of demand. There is no relationship between change in income and demand. In that case, quantity demanded remains constant for all level of income and the value of elasticity remain zero.

Fig: Zero income elasticity demand

In the given figure, Quantity demanded and income of the consumer is measured along X-axis and Y-axis respectively. The demand curve QD remains same for all level of income even the income deccreases from OY to OY₂ or increases from OY to Oy₁.

ii) Positive Income Elasticity (Ey>0)

If the quantity demand for a commodity increases with the increase in consumer's income and decreases with the income of the consumer is known as positive income elasticity. Hence, there is a positive relation between income and demand. In that case, the value of elasticity remains greater than zero.

Fig: Positive income elasticity demand

In the given figure, quantity and income demanded of a commodity is measured along X-axis and Y-axis respectively. Q₁ and Y₁ are the initial quantity demand and income of the consumer respectively. As the income of the consumer increases from Y₁ to Y₂, the quantity demanded also increases Q₁ to Q₂. DD₁ is the positive income elastic demand curve sloping upward.

iii) Negative Income Elasticity (Ey<0)

If the quantity demand of a commodity decreases with the increase in income of the consumer and increases with the decrease in income of the consumer is known as the negative elasticity of demand. Hence, there is a negative relation between quantity demand and income of the consumer. In that case, the value of elasticity remains less than zero.

Fig: Negative income elasticity demand

In the given figure, quantity and income demanded of a commodity is measured along X-axis and Y-axis respectively. Q₁ and Y₁ are the initial quantity demand and income of the consumer. When the income of the consumer increases from Y₁ to Y₂, the quantity demanded of a commodity decreases from Q₂ to Q₁. DD₁ is the negative income elastic demand curve sloping downward.

CROSSELASTICITY OF DEMAND (Exy)

Cross elasticity of demand is a measure of responsiveness of demand for a product to the change in the price of related goods. In other words, the percentage change in quantity demanded of goods due to the change in the price of a related good that may me substitute goods or complementary goods, is called cross elasticity of demand. Cross elasticity of demand is symbolized by 'Exy' and written as:

Exy = percentage change in quantity demand for X goods / Percentage change in price of Y goods

= (ΔQx / ΔPy) * (Py / Qx)

Where,

Exy = cross elasticity demand between X and Y

ΔQx = Change in quantity demand for X goods

ΔPy = Change in price of Y goods

Qx = Quantity demand of Y goods

Py = Price of Y goods

DEGREE / TYPES OF CROSS ELASTICITY OF DEMAND

There are two types of cross elasticity of demand described below:

i) Positive cross elasticity (Exy>0)

If the two goods are close substitutes to each other, then the cross elasticity of demand are said to be positive. For example, tea and coffee, when the price of a tea increases, the demand for a coffee also increase and vice versa. Hence, the increases in the price of a commodity result to the rise in a quantity demand of a substitute good.

Fig: Positive cross elasticity demand

In the given figure, quantity demand of coffee is measured along X-axis and price of tea is measured along Y-axis. When the price of tea is OP, the quantity demand of coffee is OQ. When the price of tea increases from OP₁ to OP₂, the quantity demand of coffee also increases from OQ₁ to OQ₂. Hence, the DD₁ is the positive cross demand curve sloping upward to the right.

ii) Negative cross elasticity (Exy<0)

When two goods are complementary to one another, then the cross elasticity of demand is supposed to be negative. For example, pen and ink, when the price of the ink increases, the demand for pen decreases. Hence, rise in the price of commodity results to decreases in quantity demand of complementary goods.

Fig: Negative cross elasticity demand

In the given figure, quantity demand of pen is measured along X-axis and price of ink is measured along Y-axis. When the price of ink is OP₁, the quantity demand of pen is OQ₁. When the price of the ink increases from OP₁ to OP₂, the quantity demand of pen decreases from OQ₁ to OQ₂. Hence, DD₁ is the negative cross elasticity demand curve sloping downward to the right.

(Karna, Khanal, and Chaulagain)(Khanal, Khatiwada, and Thapa)(Jha, Bhusal and Bista)

Bibliography

Jha, P.K., et al. Economics II. Kalimati, Kathmandu: Dreamland Publication, 2011.

Karna, Dr.Surendra Labh, Bhawani Prasad Khanal and Neelam Prasad Chaulagain. Economics. Kathmandu: Jupiter Publisher and Distributors Pvt. Ltd, 2070.

Khanal, Dr. Rajesh Keshar, et al. Economics II. Kathmandu: Januka Publication Pvt. Ltd., 2013.