ECON1101 Chap.6 Income, Cross-Price and Supply Elasticities
Income, Cross-Price and Supply Elasticities
Income, Cross-Price and Supply Elasticities extends elasticity beyond a good’s own price. Cross-price elasticity identifies substitutes, with a positive sign, and complements, with a negative one. Income elasticity separates normal from inferior goods and, among normal goods, necessities from luxuries.
Price elasticity of supply measures how readily sellers respond to price; it is always positive and depends on time, inventories and the availability of inputs. Each measure is computed from percentage changes on a consistent base.
Worked examples compare two households with different incomes, predict a café’s coffee sales from three elasticities, and read point elasticities off a demand function that contains income and a related price.
What this chapter covers
- 01
Cross-price elasticity of demand
- 02
Substitutes and complements by sign
- 03
Income elasticity of demand
- 04
Necessities and luxuries
- 05
Price elasticity of supply
- 06
What makes supply elastic
Worked example · free
Income elasticities from two households
- 1Income is 25% higher for B; with equal prices, the percentage gap in spending equals the gap in quantity.
- 1Bus trips: −20%/25% = −0.80, inferior.
- 1Groceries: 6.25%/25% = 0.25, a necessity; their budget share falls from 20% to 17%.
- 1Gym classes: 50%/25% = 2.00 and travel 66.7%/25% = 2.67, luxuries whose budget shares rise.
Key terms
- Cross-price elasticity
- Cross-price elasticity is the percentage change in demand for one good divided by the percentage change in another good’s price.
- Income elasticity
- Income elasticity measures how strongly quantity demanded responds, in percentage terms, to a percentage change in income.
- Luxury good
- A luxury good is a normal good whose demand rises more than in proportion to income, with income elasticity above one.
- Price elasticity of supply
- Price elasticity of supply is the responsiveness of quantity supplied to price, measured in percentage terms and always positive.
Income, Cross-Price and Supply Elasticities FAQ
How do I know whether two goods are substitutes or complements?
Look at the sign of the cross-price elasticity. If a higher price of one good raises demand for the other, the sign is positive and they are substitutes; if it lowers demand, the sign is negative and they are complements.
Can a good be a necessity and still be normal?
Yes. Necessities are normal goods with an income elasticity between zero and one: buyers purchase more as income rises, but less than in proportion. Inferior goods are the ones with negative income elasticity.
Why is supply more elastic in the long run?
Sellers need time to add capacity, such as equipment, buildings or trained staff. In the short run output can only rise within existing capacity, so quantity responds less to a price change than it does once capacity can grow.
Is price elasticity of supply ever negative?
Not in this course. Price and quantity supplied move together under the law of supply, so the ratio of their percentage changes is positive; the classification uses its size relative to one.
How is income elasticity linked to shifts of the demand curve?
A change in income shifts the demand curve rather than moving buyers along it. Income elasticity measures the size and direction of that shift in percentage terms: positive and large for a luxury, positive and small for a necessity, negative for an inferior good.
What does a cross-price elasticity close to zero mean?
It means a change in one good’s price barely affects demand for the other, so the two goods are close to unrelated for those buyers. A large positive value signals close substitutes, and a large negative value signals strong complements that are usually bought together.
Exam move
Make a one-page sign table for the three elasticities and test yourself until you can classify any good from a sign and a size in seconds. Then work two numerical items, one comparing households with different incomes and one with a demand function that includes income and other prices. Close with supply: give one reason why each of three goods you buy would have elastic or inelastic supply.
Before an exam, write each formula with its base values circled; most errors in this chapter come from dividing a change by the wrong starting value rather than from the concepts themselves. Then test the supply side with goods you know: fresh fruit, cars and wine each illustrate one of the three determinants the course names.
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