Question

1. The concept of elasticity.

A) As additional demanders enter the market for a particular good, the market demand curve shifts outward and becomes flatter at a given price. Does this fact imply that the price elasticity of demand becomes greater (a higher numerical value) for a given price? Carefully demonstrate and explain your answer.

B) How can information about an individual's income elasticity of demand be useful in determining the direction of the income effect when the total effect of a decrease in the price of a good is decomposed into the substitution and income effects? Carefully explain your reasoning.

Answer 1

A

As additional demanders enter the market for a particular good, it leads to an increase in demand for that good. Hence it leads to the situation of excess demand. Demand curve shifts outward and becomes flatter for any given price.
Equilibrium price is below the expected price. So to reach out to equilibrium, price must increase. And for that thing to take place, there will be larger supply and higher competition among producers. Price can settle down in between the expected and current price.
Considering this scenario, Price elasticity goes down as it becomes more to the inelastic phase. Since there are more demanders but there is not enough supply to cater the demanders.

B.

In analyzing the effect of a decrease in price of a good, we come across two effects: income and substitution effect. As we know income effect is important. Income elasticity is useful in the context of categorizing the good into normal good, luxury good, necessity, inferior good. Also we know that if a good is inferior good and relative price effect(substitution effect) is lower than income effect, then a good is said to be giffen good. So income elasticity measure is really helpful in such cases.