Income and Cross Price Elasticity of Demand - PowerPoint

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					                                        AS Economics
Income Elasticity of Demand    PowerPoint Briefings 2006




                AS Economics
                                                         Key Issues

•   The meaning of income elasticity of demand
•   Measuring income elasticity
•   Normal goods
•   Luxury goods
•   Necessities
•   Inferior Goods
•   Income elasticity of demand and the economic cycle




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                         Income Elasticity of Demand

• Income elasticity of demand (Yed) measures the
  relationship between a change in quantity demanded
  and a change in real income
• Yed = % change in demand / % change in income
• Example:
  – A rise in consumer income of 5% leads to an 8% rise
    in demand for cinema admissions
  – The income elasticity of demand = +8/+5 = +1.66


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                                                Normal Goods

• Normal goods have a positive and high income elasticity of
  demand so as consumers’ income rises, so more is
  demanded at each price level
• (i) Necessities have a low but positive income elasticity of
  demand of between 0 and +1
• (ii) Luxuries have an income elasticity of demand > +1 i.e. the
  demand rises more than proportionate to a change in income




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                                                  Inferior Goods

• Inferior goods have a negative income elasticity of demand.
  Demand falls as income rises
• For example:
   – A 10% rise in incomes leads to a 4% decrease in the demand
     for bus travel
   – The income elasticity of demand = -4/+10
   – Yed = -0.4




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                      Different Types of Goods and
                              their Income Elasticity

Normal Luxury

Air travel

Fine wines
Luxury chocolates
Private education
Private health care
Antique furniture


Designer clothes

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                              Different Types of Goods and
                                      their Income Elasticity

Normal Luxury         Normal Necessity

Air travel            Fresh vegetables

Fine wines            Instant coffee
Luxury chocolates     Natural cheese
Private education     Fruit juice
Private health care   Spending on utilities
Antique furniture     Shampoo /
                      toothpaste /
                      detergents
Designer clothes      Rail travel

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                              Different Types of Goods and
                                      their Income Elasticity

Normal Luxury         Normal Necessity        Inferior Good

Air travel            Fresh vegetables        Frozen vegetables

Fine wines            Instant coffee          Cigarettes
Luxury chocolates     Natural cheese          Processed cheese
Private education     Fruit juice             Margarine
Private health care   Spending on utilities   Tinned meat
Antique furniture     Shampoo /               Value “own-brand”
                      toothpaste /            bread
                      detergents
Designer clothes      Rail travel             Bus travel

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                                                          Relationship between Income
                                                               and Quantity Demanded
Quantity




               Zero
               income
               elasticity        Positive income elasticity              Negative income elasticity
                                                                         [inferior good]




           0                y1                                      y2
                                                 Income

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Expenditure on a product
                                         The Engels Curve


                                         All Goods and Services




                           Real Income
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Expenditure on a product
                                         The Engels Curve


                                         All Goods and Services




                                         Food and Clothing




                           Real Income
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                           Income Elasticity of Demand for
                                                 Chocolate
• Total consumption
   – USA +0.79
   – Germany +0.39
   – United Kingdom +0.44
   – France +0.60
   – Japan +0.1
   – Switzerland +1.06
• Reference: Henri Jason Trends in cocoa and chocolate
  consumption with particular reference to developments in the major
  markets. Malaysian International Cocoa Conference, Kuala
  Lumpur, 20-21 October 1994 (ICCO, ED(MEM) 686)


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                                              Income Elasticity and the
                                              Demand for Airline Travel
•   Demand for air travel has a positive income
    elasticity of demand
•   The industry is cyclical
     – During an upturn, demand rises for
       business and leisure travel)
     – During a recession, the demand tails
       away
•   In the long run, there is a positive
    relationship between real GDP per capita
    and the demand for air travel
•   Income elasticity will vary according to the
    type of air travel
     – E.g. difference between low-cost “no-
       frills” and higher priced scheduled
       services on low-haul flights

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                                                                                             Income Per Capita and Airline
                                                                                                        Travel by Country
             100000




                                                                                                                                                         Singapore

                                                                                                                              Hong Kong China
                       10000
                                                                                             New Zealand                                                      US
                                                                                                                 Australia                Sw itzerland

                                                                                                                     Netherlands Canada
ASK (000) per capita




                                                                                                        Israel                          Denmark
                                                     Ecuador                                                              UK
                                                                                                                                             Norw ay
                                                                                                   Spain                        France        Japan
                                                              Malaysia                                                Finland
                                                                       Saudi Arabia Greece               IrelandSw eden Germany        Belgium
                                                    Thailand                                    Portugal                         Austria
                       1000         Dominican Rep               Panama                      Korea Rep
                                                                 S. Africa                                              Italy
                                                 Lebanon                              Chile
                                                Costa Rica             Mexico
                                             Peru               Brazil    Venezuela
                                   Philippines          Tunisia  Hungary
                            Sri Lanka                           Colombia       Argentina
                              Kenya Zimbabw e Bulgaria Turkey                    Czech Rep
                                                        Croatia          Uruguay
                            Cote D'Ivoire                                           Slovenia
                                             Syria Lithuania
                            Pakistan Paraguay Romania Poland
                        100
                               Vietnam China Algeria Iran
                                       Cameroon     Belarus
                                 India  Ukraine
                                    Nigeria
                                   Bangladesh


                         10
                               0                 5000                  10000                 15000                 20000                 25000                     30000     35000
                                                                                             GNP per capita ($ PPP)
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                                                                          Income and car ownership

                                  Car ownership and income levels 1981 - 2002
                                                                                      Source: Department for Transport



                  420
                                                     2002
                  400
                  380

                  360
                                        1996
Cars per 000 of




                  340
 population




                                                                                                             2002
                  320                                                                 1996
                                 1991                                      1991
                  300                                        1986
                  280
                          1986
                  260
                  240

                  220
                    260   300     340          380          420     460    500      540       580        620         660
                                                     Income (£/week, 2002 prices)
                                                       All metropolitan areas     London
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                           Significance of Income Elasticity
                                                of Demand
• High Income Elasticity
   – Demand is sensitive to changes in real incomes
   – Demand is therefore cyclical – in an economic expansion,
     demand will grow strongly. In a recession demand may fall
   – Can be difficult for businesses to accurately forecast demand
     and make capital investment decisions




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                          Significance of Income Elasticity
                                               of Demand
• Low Income Elasticity
   – Demand is more stable during fluctuations in the economic
     cycle
   – Over time, the share of consumer spending on inferior goods
     and normal necessities tends to decline
   – Long run – businesses need to invest in / focus on products
     with a higher income elasticity of demand if they want to
     increase total profits




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