1. Qd always responds positively to the change in income. QdQd O Y More Elastic Less Elastic

2. Recap

3. D D` Q P Inelastic D D` Elastic D D`` ∆ Y in PQ space D``

4. Example Income (Rs) Quantity Demanded (units) 10000100 12000105 YЄ d = ∆ Q ÷ ∆ Y Q Y = 5 ÷ 2000 100 10000 = 0.25 The Good is normal (the sign is positive). But its demand is income inelastic o< | Є | < 1. Rule: If sign is positive the good is normal and if sign is negative the good is inferior.

5. Determinants of income elasticity of demand 1. Degree of necessity of good. 2. The rate at which the desire for good is satisfied as consumption increases 3. The level of income of consumer.

6. Food Stuff YЄdYЄd M i l k-0.40 E g g s-0.41 M u t t o n-0.21 B r e a d-0.25 B u t t e r-0.04 M a r g a r I n e-0.44 S u g a r-0.54 F r e s h P o t a t o e s-0.48 T e a-0.56 C h e e s e0.19 B e e f0.08 C a k e s & B u i s c u i t s0.02 F r e s h G r e e n V e g e t a b l e s0.13 F r e s h F r u i t0.48 F r e s h J u i c e s0.94 C o f f e e0.23 E l a s t i c I t y F o r A l l F o o d-0.01

7. Cross price elasticity of demand It is defined as the percentage change in quantity demanded of good A divided by the percentage change in the price of another related good B.

8. Example Demand for APrice of B 10010 14012 P b Є d a = ∆ Qa ÷ ∆ Pb Q a Pb = 40 ÷ 2 100 10 = 2 Goods are substitutes ( sign is positive ) Demand is cross price elastic | є | > 1. Rule: If a sign is positive the goods are substitutes and if a sign is negative the goods are complements

9. Example 2 A Government will wish to know how a change inA Government will wish to know how a change in domestic prices will affect the demand for imports. domestic prices will affect the demand for imports. Rise in price of imports worsening the Balance ofRise in price of imports worsening the Balance of payments payments

10. Adjusting to oil price shocks SHORT RUN P A P1P1 Q P2P2 Q1Q1 Q2Q2 S1S1 S2S2 B D1D1 O

11. Adjusting to oil price shocks Long Run effect on demand P A P1P1 Q P2P2 S1S1 S2S2 B D1D1 D2D2 CDLDL O

12. Adjusting to oil price shocks P D P1P1 Q P2P2 S1S1 S2S2 Long Run effect on supply D1D1 B S3S3 F E SLSL O

13. Incidence of tax when the demand is inelastic Fixed TaxFixed Tax P B P0P0 Q P1P1 Q0Q0 Q1Q1 S1S1 S2S2 C TAXTAX D A D X D

14. Incidence of tax when the demand is elastic Fixed TaxFixed Tax P B` P0P0 Q P1P1 Q0Q0 Q1Q1 S0S0 S1S1 C` A` O X` D` D TAXTAX

15. Inelastic demand Case 1Case 1 P P1P1 Q P2P2 Q1Q1 Q2Q2 S1S1 S + Tax O D TAXTAX

16. Elastic demand Case 2Case 2 P P1P1 Q P2P2 Q1Q1 Q2Q2 S1S1 S + Tax O D TAXTAX

17. Inelastic supply Case 3Case 3 P P1P1 Q P2P2 Q1Q1 Q2Q2 S S + Tax O D TAXTAX

18. Elastic supply Case 4Case 4 P P1P1 Q P2P2 Q1Q1 Q2Q2 S S + Tax O D TAXTAX

19. Tax on smoking Case 1Case 1 P P1P1 Q P2P2 Q1Q1 Q2Q2 S1S1 S + Tax O D TAXTAX

20. Tax on environmental pollution Case 3Case 3 P P1P1 Q P2P2 Q1Q1 Q2Q2 S S + Tax O D TAXTAX

21. 3 Core rules of elasticity RULE # 1: 1 Less thanGreater than InelasticElastic RULE # 2: Income elasticity + – Normal good Inferior good RULE # 3: Cross elasticity – Complements + Substitutes Summary