Cross Elasticity and Income Elasticity

Background: Domino’s Pizza has a BIG problem! Burger King just cut its prices. Pat, the manager of Domino’s, knows that pizzas and burgers are substitutes. He also knows that when the price of a substitute for pizza falls, the demand for pizza decreases. How much will the quantity of pizza bought decrease if Pat maintains his current price?

Background: Also, pizza and soda are complements. He knows that if the price of a complement of pizza falls, the demand for pizza increases. So could he keep his customers by cutting the price he charges for soda? But how much must he cut the price of soda to keep selling the same quantity of pizza with cheaper burgers at Burger King?

Cross Elasticity of Demand Measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement when other things remain the same.

Cross Elasticity of Demand Percentage change in quantity demanded of a good Percentage change in the price of one of its substitutes or complements = Price of a burger falls by 10%, the quantity of pizza demanded decreases by 5%. Cross elasticity of demand for a substitute is positive. A FALL in the price of a substitute brings a DECREASE in the quantity demanded for a good The quantity demanded of a good and the price of one of it substitute changes in the same direction Cross elasticity of demand – 5 percent – 10 percent = 0.5

Cross elasticity of demand When the price of soda falls by 10%, the quantity of pizza demanded increases by 2%. Cross elasticity of demand for a complement is negative. A FALL in the price of a complement brings an INCREASE in the quantity demanded of the good. The quantity demanded of a good and the price of one of its complement change in opposite directions Cross elasticity of demand + 2 percent – 10 percent = - 0.2

Cross Elasticity of Demand Pizzas and burgers are substitutes. When the price of a burger falls, the demand for pizza decreases. Cross elasticity of demand is positive

Cross Elasticity of Demand Pizzas and soda are complements. When the price of soda falls, the demand for pizza increases. Cross elasticity of demand is negative.

Income Elasticity Measure of the responsiveness of the demand for a good to a change in income when other things remain the same. Income elasticity of demand falls into three ranges: Greater than 1 (normal good, income elastic) Between zero and 1 (normal good, income inelastic) Less than zero (inferior good) Income elasticity of demand Percentage change in quantity demanded Percentage change in income =

Income Elasticity As income increase, items that have an income elastic demand take an increasing share of income Items that have an income elastic demand take a decreasing share of income Items that have a negative income elasticity of demand take an absolutely smaller amount of income

Cross Elasticity and Income Elasticity Notes

Background: Domino’s Pizza has a BIG problem! Burger King just cut its prices. Pat, the manager of Domino’s, knows that pizzas and burgers are substitutes. He also knows that when the price of a substitute for pizza falls, the demand for pizza decreases. How much will the quantity of pizza bought decrease if Pat maintains his current price?

Background: Also, pizza and soda are ______________. He knows that if the price of a complement of pizza falls, the demand for pizza increases. So could he keep his customers by cutting the price he charges for soda? But how much must he cut the price of soda to keep selling the same quantity of pizza with cheaper burgers at Burger King?

Cross Elasticity of Demand

Cross elasticity of demand = Price of a burger falls by 10%, the quantity of pizza demanded decreases by 5%. Cross elasticity of demand for a substitute is positive. A ________ in the price of a substitute brings a ____________ in the quantity demanded for a good The quantity demanded of a good and the price of one of it substitute changes in the same direction Cross elasticity of demand – 5 percent – 10 percent = 0.5

Cross elasticity of demand When the price of soda falls by 10%, the quantity of pizza demanded increases by 2%. Cross elasticity of demand for a complement is negative. A ________ in the price of a complement brings an _____________ in the quantity demanded of the good. The quantity demanded of a good and the price of one of its complement change in opposite directions Cross elasticity of demand + 2 percent – 10 percent = - 0.2

Cross Elasticity of Demand

Cross Elasticity of Demand

Income Elasticity Measure of the responsiveness of the demand for a good to a change in income when other things remain the same. Income elasticity of demand falls into three ranges: Greater than 1 (normal good, income _____) Between zero and 1 (normal good, income _____________) Less than zero (_____________) =

Income Elasticity As income increase, items that have an income ___________demand take an ____________ share of income Items that have an income ___________elastic demand take a ________________ share of income Items that have a __________ income elasticity of demand take an absolutely ________________amount of income