Question

Please discuss briefly income and cross elasticities of demand with examples related to business world.

Answer 1

Income elasticity of demand means the degree of responsiveness of quantity demanded of a commodity to changes in income of the consumers.Income elasticity can be positive ,negative or zero.

Positive income elasticity .Increase in income causes increase in demand for commodities.If income increases people spend more especially on normal goods.Example,comforts and luxuries.Then it is called positive income elasticity.

Negative income elasticity.Increase in income leads to fall in the demand for certain commodities . Example ,inferior goods.Consumer will switch over from inferior goods to superior goods as they can afford to buy these goods with the increased income.

Zero income elasticity means rise in income leaves quantity demanded unchanged.Example,Salt.Increase in income may not bring change in demand for such commodities.

Cross elasticity of demand means the responsiveness of demand for one commodity to change in price of the other commodity..There are three types of cross elasticity.

Positive cross elasticity of demand.When increase in the price of one commodity leads to an increase in demand for the other commodity.it is said to be positive cross elasticity .Example. A fall in the price of coffee increases the demand for coffee but demand for tea falls as they are substitutes .Consumer will switch over from tea to coffee as coffee is cheap.

Negative cross elasticity.Increase in the price of one commodity causes a fall in the demand for another commodity.This happens in the case of complementary goods.Example ,Car and Petrol.A fall in the price of car causes an increase in demand for petrol and car.

Zero income elasticity.When change in price of of one commodity does not affect the demand for another commodity.Example ,Tea and TV set.A change in the price of tea does not affect the demand for TV set.

The concept of cross elasticity plays an important role in taking various business decisions..Whether the price of the commodity is to be increased or not is to be taken by knowing its substitutes and complements. Raising prices will be advisable if the elasticity of demand for its substitutes is low because otherwise consumers will shift to the consumption of these substitutes as the firm raises the price of its product.

Similarly business firms should have a idea about income elasticity of demand while deciding to undertake additional capacity.They would find it profitable to increase the production capacity of those products which have a high income elasticity of demand.