Final ED Word Document

8/9/2019 Final ED Word Document

1/19

TYPES OF ELASTICITY OF DEMAND

Price elasticity of demand

PED is derived from the percentage change in quantity (%Qd) and

percentage change in price (%P).

Price elasticity of demand (PED or Ed) is a measure used in economics to

show the responsiveness, or elasticity, of the quantity demanded of a good

or service to a change in its price. More precisely, it gives the percentagechange in quantity demanded in response to a one percent change in price

(holding constant all the other determinants of demand, such as income). Itwas devised by Alfred Marshall.

Price elasticities are almost always negative, although analysts tend to

ignore the sign even though this can lead to ambiguity. Only goods which do

not conform to the law of demand, such as Veblen and Giffen goods, have apositive PED. In general, the demand for a good is said to be inelastic (or

relatively inelastic) when the PED is less than one (in absolute value): thatis, changes in price have a relatively small effect on the quantity of the good

demanded. The demand for a good is said to be elastic(or relatively elastic)when its PED is greater than one (in absolute value): that is, changes in

price have a relatively large effect on the quantity of a good demanded.

Revenue is maximised when price is set so that the PED is exactly one. ThePED of a good can also be used to predict the incidence (or "burden") of atax on that good. Various research methods are used to determine price

elasticity, including test markets, analysis of historical sales data and

conjoint analysis.

Definition
http://en.wikipedia.org/wiki/Elasticity_(economics)http://en.wikipedia.org/wiki/Alfred_Marshallhttp://en.wikipedia.org/wiki/Law_of_demandhttp://en.wikipedia.org/wiki/Veblen_goodhttp://en.wikipedia.org/wiki/Giffen_goodhttp://en.wikipedia.org/wiki/Incidence_of_taxhttp://en.wikipedia.org/wiki/Incidence_of_taxhttp://en.wikipedia.org/wiki/Marketing_researchhttp://en.wikipedia.org/wiki/Conjoint_analysis_(in_marketing)http://en.wikipedia.org/wiki/File:Price_elasticity_of_demand.svghttp://en.wikipedia.org/wiki/Elasticity_(economics)http://en.wikipedia.org/wiki/Alfred_Marshallhttp://en.wikipedia.org/wiki/Law_of_demandhttp://en.wikipedia.org/wiki/Veblen_goodhttp://en.wikipedia.org/wiki/Giffen_goodhttp://en.wikipedia.org/wiki/Incidence_of_taxhttp://en.wikipedia.org/wiki/Incidence_of_taxhttp://en.wikipedia.org/wiki/Marketing_researchhttp://en.wikipedia.org/wiki/Conjoint_analysis_(in_marketing)


2/19

PED is a measure of the sensitivity (or responsiveness) of the quantity of a

good or service demanded to changes in its price.[1] The formula for thecoefficient of price elasticity of demand for a good is:

The above formula usually yields a negative value, due to the inverse nature

of the relationship between price and quantity demanded, as described by

the "law of demand".[3] For example, if the price increases by 5% andquantity demanded decreases by 5%, then the elasticity at the initial price

and quantity = 5%/5% = 1. The only classes of goods which have a PEDof greater than 0 are Veblen and Giffen goods. Because the PED is negative

for the vast majority of goods and services, however, economists often refer

to price elasticity of demand as a positive value (i.e., in absolute valueterms).

This measure of elasticity is sometimes referred to as the own-priceelasticity of demand for a good, i.e., the elasticity of demand with respect to

the good's own price, in order to distinguish it from the elasticity of demand

for that good with respect to the change in the price of some other good,i.e., a complementary or substitute good.[1] The latter type of elasticity

measure is called a cross-price elasticity of demand.

As the difference between the two prices or quantities increases, theaccuracy of the PED given by the formula above decreases for a combination

of two reasons. First, the PED for a good is not necessarily constant; as

explained below, PED can vary at different points along the demand curve,due to its percentage nature.[8][9] Elasticity is not the same thing as the slope

of the demand curve, which is dependent on the units used for both priceand quantity.[10][11] Second, percentage changes are not symmetric; instead,

the percentage change between any two values depends on which one ischosen as the starting value and which as the ending value. For example, if

quantity demanded increases from 10 units to 15 units, the percentage

change is 50%, i.e., (15 10) 10 (converted to a percentage). But ifquantity demanded decreases from 15 units to 10 units, the percentage

change is 33.3%, i.e., (15 10) 15.

Two alternative elasticity measures avoid or minimise these shortcomings of

the basic elasticity formula:point-price elasticityand arc elasticity.

Income elasticity of demand
http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Png57-0http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Gillespie43-2http://en.wikipedia.org/wiki/Absolute_valuehttp://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Substitute_goodhttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Png57-0http://en.wikipedia.org/wiki/Cross-price_elasticity_of_demandhttp://en.wikipedia.org/wiki/Cross-price_elasticity_of_demandhttp://en.wikipedia.org/wiki/Demand_curvehttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-7http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-8http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-parkin75-9http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-10http://en.wikipedia.org/wiki/Percentage#Percentage_increase_and_decreasehttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Png57-0http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Gillespie43-2http://en.wikipedia.org/wiki/Absolute_valuehttp://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Substitute_goodhttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Png57-0http://en.wikipedia.org/wiki/Cross-price_elasticity_of_demandhttp://en.wikipedia.org/wiki/Demand_curvehttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-7http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-8http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-parkin75-9http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-10http://en.wikipedia.org/wiki/Percentage#Percentage_increase_and_decrease


3/19

In economics, income elasticity ofdemand measures the responsiveness

of the demand for a good to a change in the income of the peopledemanding the good. It is calculated as the ratio of the percentage change in

demand to the percentage change in income. For example, if, in response toa 10% increase in income, the demand for a good increased by 20%, the

income elasticity of demand would be 20%/10% = 2.

Interpretation

Inferior good's demand falls as consumer income increases.

A negative income elasticity of demand is associated with inferior goods; an

increase in income will lead to a fall in the demand and may lead to changesto more luxurious substitutes.

A positive income elasticity of demand is associated with normal goods; an

increase in income will lead to a rise in demand. If income elasticity of

demand of a commodity is less than 1, it is a necessity good. If the elasticityof demand is greater than 1, it is a luxury good or a superior good.

A zero income elasticity (or inelastic) demand occurs when an increase inincome is not associated with a change in the demand of a good. These

would be sticky goods.

Mathematical definition

More formally, the income elasticity of demand, , for a given Marshallian

demand function for a good is
http://en.wikipedia.org/wiki/Elasticity_(economics)http://en.wikipedia.org/wiki/Supply_and_demandhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Normal_goodhttp://en.wikipedia.org/wiki/Luxury_goodhttp://en.wikipedia.org/wiki/Superior_goodhttp://en.wikipedia.org/wiki/Sticky_(economics)http://en.wikipedia.org/wiki/Marshallian_demand_functionhttp://en.wikipedia.org/wiki/Marshallian_demand_functionhttp://en.wikipedia.org/wiki/File:Income_elasticity_of_demand_-_inferior_goods.svghttp://en.wikipedia.org/wiki/Elasticity_(economics)http://en.wikipedia.org/wiki/Supply_and_demandhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Normal_goodhttp://en.wikipedia.org/wiki/Luxury_goodhttp://en.wikipedia.org/wiki/Superior_goodhttp://en.wikipedia.org/wiki/Sticky_(economics)http://en.wikipedia.org/wiki/Marshallian_demand_functionhttp://en.wikipedia.org/wiki/Marshallian_demand_function


4/19

or alternatively:

This can be rewritten in the form:

With income I, and vector of prices . Many necessities have an incomeelasticity of demand between zero and one: expenditure on these goods may

increase with income, but not as fast as income does, so the proportion ofexpenditure on these goods falls as income rises. This observation for food is

known as Engel's law.

Cross Elasticity of Demand

Here, a change in the price of one good causes a change in the demand for

another.

Cross elasticity of Demand

Proportionate change in purchases of commodity Xfor X and Y = ---------------------------------------------------------------

Proportionate change in the price of commodity Y

This type of elasticity arises in the case of inter-related goods such assubstitutes and complementary goods.

The two commodities will be complementary, if a fall in the price of Y

increases the demand for X and conversely, if a rise in the price of onecommodity decreases the demand for the other. They will be substitute or

rival goods if a reduction in the price of Y decreases the demand for X, and

also if a rise in price of one commodity (say tea) increases the demand forthe other commodity (say coffee). The cross elasticity of complementary

goods is positive and that between substitutes, it is negative. It should,however, be remembered that cross elasticity will indicate complementarities

or rivalry only if the commodities in question figure in the family budget in

small proportions.

Cross elasticity of demand can be used to indicate boundaries between

industries. Goods with high cross elasticity constitute one industry, whereas

goods with low cross elasticity constitute different industries. It is not to be

supposed that cross elasticity represents reciprocal relationship. It is not a
http://en.wikipedia.org/wiki/Necessityhttp://en.wikipedia.org/wiki/Engel's_lawhttp://en.wikipedia.org/wiki/Necessityhttp://en.wikipedia.org/wiki/Engel's_law


5/19

two-way street. The cross elasticity of a tea with respect to coffee is not

the same as that of coffee with respect to tea. The tastes of the consumer,

his money income and all prices except of the commodity Y are assumed to

remain constant.

Five cases of ED

Elastic- ( E>1 ) The demand for an item/good is strongly affected by thechange in price. This is where a change in a price causes a

proportionately smaller change in the quantity demanded. In this casethe value of elasticity will be greater than 1, since we are dividing larger

figure by smaller figure

Price

P1

P0

D

O Q1 Q0 Quantity

Inelastic- (E


6/19

P010%

0

q1 qo

Quantity

Unit elastic - Describes a demand curve which is perfectly responsive to

changes in price. That is, the quantity supplied or demanded changesaccording to the same percentage as the change in price. A curve with an

elasticity of 1 is unit elastic. Not really any real life examples

Price

Po 20%

P1 20%

D

Qo Q1

Quantity

PERFECTLY INELASTIC: (E = ) An elasticity alternative in which infinitesimally small

changes in one variable (usually price) cause infinitely large changes in another variable (usuallyquantity). Quantity is infinitely responsive to price. Any change in price, no matter how small,

triggers an infinite change in quantity. If the negative sign is not ignored, then the price elasticity

of demand is given by E = -.

D

Price

P1 10%

Po

O Qo

Quantity


7/19

Other Types of ED(PED, IED, CED)

Price elasticity of demand

PED is derived from the percentage change in quantity (%Qd) and

percentage change in price (%P).

Price elasticity of demand (PED or Ed) is a measure used in economics toshow the responsiveness, or elasticity, of the quantity demanded of a good

or service to a change in its price. More precisely, it gives the percentagechange in quantity demanded in response to a one percent change in price

(holding constant all the other determinants of demand, such as income). It

was devised by Alfred Marshall.

Price elasticities are almost always negative, although analysts tend to

ignore the sign even though this can lead to ambiguity. Only goods which donot conform to the law of demand, such as Veblen and Giffen goods, have a

positive PED. In general, the demand for a good is said to be inelastic (orrelatively inelastic) when the PED is less than one (in absolute value): thatis, changes in price have a relatively small effect on the quantity of the good

demanded. The demand for a good is said to be elastic(or relatively elastic)when its PED is greater than one (in absolute value): that is, changes in

price have a relatively large effect on the quantity of a good demanded.

Revenue is maximised when price is set so that the PED is exactly one. The

PED of a good can also be used to predict the incidence (or "burden") of atax on that good. Various research methods are used to determine price

elasticity, including test markets, analysis of historical sales data and

conjoint analysis.

Definition
http://en.wikipedia.org/wiki/Elasticity_(economics)http://en.wikipedia.org/wiki/Alfred_Marshallhttp://en.wikipedia.org/wiki/Law_of_demandhttp://en.wikipedia.org/wiki/Veblen_goodhttp://en.wikipedia.org/wiki/Giffen_goodhttp://en.wikipedia.org/wiki/Incidence_of_taxhttp://en.wikipedia.org/wiki/Incidence_of_taxhttp://en.wikipedia.org/wiki/Marketing_researchhttp://en.wikipedia.org/wiki/Conjoint_analysis_(in_marketing)http://en.wikipedia.org/wiki/File:Price_elasticity_of_demand.svghttp://en.wikipedia.org/wiki/Elasticity_(economics)http://en.wikipedia.org/wiki/Alfred_Marshallhttp://en.wikipedia.org/wiki/Law_of_demandhttp://en.wikipedia.org/wiki/Veblen_goodhttp://en.wikipedia.org/wiki/Giffen_goodhttp://en.wikipedia.org/wiki/Incidence_of_taxhttp://en.wikipedia.org/wiki/Incidence_of_taxhttp://en.wikipedia.org/wiki/Marketing_researchhttp://en.wikipedia.org/wiki/Conjoint_analysis_(in_marketing)


8/19

PED is a measure of the sensitivity (or responsiveness) of the quantity of a

good or service demanded to changes in its price.[1] The formula for thecoefficient of price elasticity of demand for a good is:

The above formula usually yields a negative value, due to the inverse nature

of the relationship between price and quantity demanded, as described by

the "law of demand".[3] For example, if the price increases by 5% andquantity demanded decreases by 5%, then the elasticity at the initial price

and quantity = 5%/5% = 1. The only classes of goods which have a PEDof greater than 0 are Veblen and Giffen goods. Because the PED is negative

for the vast majority of goods and services, however, economists often refer

to price elasticity of demand as a positive value (i.e., in absolute valueterms).

This measure of elasticity is sometimes referred to as the own-priceelasticity of demand for a good, i.e., the elasticity of demand with respect to

the good's own price, in order to distinguish it from the elasticity of demand

for that good with respect to the change in the price of some other good,i.e., a complementary or substitute good.[1] The latter type of elasticity

measure is called a cross-price elasticity of demand.

As the difference between the two prices or quantities increases, theaccuracy of the PED given by the formula above decreases for a combination

of two reasons. First, the PED for a good is not necessarily constant; as

explained below, PED can vary at different points along the demand curve,due to its percentage nature.[8][9] Elasticity is not the same thing as the slope

of the demand curve, which is dependent on the units used for both priceand quantity.[10][11] Second, percentage changes are not symmetric; instead,

the percentage change between any two values depends on which one ischosen as the starting value and which as the ending value. For example, if

quantity demanded increases from 10 units to 15 units, the percentage

change is 50%, i.e., (15 10) 10 (converted to a percentage). But ifquantity demanded decreases from 15 units to 10 units, the percentage

change is 33.3%, i.e., (15 10) 15.

Two alternative elasticity measures avoid or minimise these shortcomings of

the basic elasticity formula:point-price elasticityand arc elasticity.

Point-price elasticity

One way to avoid the accuracy problem described above is to minimize thedifference between the starting and ending prices and quantities. This is the

approach taken in the definition ofpoint-price elasticity, which uses
http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Png57-0http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Gillespie43-2http://en.wikipedia.org/wiki/Absolute_valuehttp://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Substitute_goodhttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Png57-0http://en.wikipedia.org/wiki/Cross-price_elasticity_of_demandhttp://en.wikipedia.org/wiki/Cross-price_elasticity_of_demandhttp://en.wikipedia.org/wiki/Demand_curvehttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-7http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-8http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-parkin75-9http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-10http://en.wikipedia.org/wiki/Percentage#Percentage_increase_and_decreasehttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Png57-0http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Gillespie43-2http://en.wikipedia.org/wiki/Absolute_valuehttp://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Substitute_goodhttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-Png57-0http://en.wikipedia.org/wiki/Cross-price_elasticity_of_demandhttp://en.wikipedia.org/wiki/Demand_curvehttp://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-7http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-8http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-parkin75-9http://i/Copy%20of%20iftekhar/price%20elasticity%20%20of%20demand/Price_elasticity_of_demand.htm#cite_note-10http://en.wikipedia.org/wiki/Percentage#Percentage_increase_and_decrease


9/19

differential calculus to calculate the elasticity for an infinitesimal change in

price and quantity at any given point on the demand curve:

In other words, it is equal to the absolute value of the first derivative ofquantity with respect to price (dQd/dP) multiplied by the point's price (P)

divided by its quantity (Qd).

In terms of partial-differential calculus, point-price elasticity of demand can

be defined as follows: let be the demand of goods as a

function of parameters price and wealth, and let be the demand for

good . The elasticity of demand for good with respect to pricepk is

However, the point-price elasticity can be computed only if the formula forthe demand function, Qd = f(P), is known so its derivative with respect to

price, dQd/ dP, can be determined.

Arc elasticity

A second solution to the asymmetry problem of having a PED dependent on

which of the two given points on a demand curve is chosen as the "original"

point and which as the "new" one is to compute the percentage change in Pand Q relative to the average of the two prices and the average of the two

quantities, rather than just the change relative to one point or the other.Loosely speaking, this gives an "average" elasticity for the section of the

actual demand curvei.e., the arcof the curvebetween the two points. Asa result, this measure is known as the arc elasticity, in this case with respect

to the price of the good. The arc elasticity is defined mathematically as:

This method for computing the price elasticity is also known as the

"midpoints formula", because the average price and average quantity are

the coordinates of the midpoint of the straight line between the two givenpoints. However, because this formula implicitly assumes the section of the

demand curve between those points is linear, the greater the curvature ofthe actual demand curve is over that range, the worse this approximation of

its elasticity will be.
http://en.wikipedia.org/wiki/Differential_calculushttp://en.wikipedia.org/wiki/Demand_curve#Demand_schedulehttp://en.wikipedia.org/wiki/Arc_elasticityhttp://en.wikipedia.org/wiki/Differential_calculushttp://en.wikipedia.org/wiki/Demand_curve#Demand_schedulehttp://en.wikipedia.org/wiki/Arc_elasticity


10/19

Income elasticity of demand

In economics, income elasticity ofdemand measures the responsiveness

of the demand for a good to a change in the income of the people

demanding the good. It is calculated as the ratio of the percentage change indemand to the percentage change in income. For example, if, in response to

a 10% increase in income, the demand for a good increased by 20%, theincome elasticity of demand would be 20%/10% = 2.

Interpretation

Inferior good's demand falls as consumer income increases.

A negative income elasticity of demand is associated with inferior goods; an

increase in income will lead to a fall in the demand and may lead to changesto more luxurious substitutes.

A positive income elasticity of demand is associated with normal goods; an

increase in income will lead to a rise in demand. If income elasticity ofdemand of a commodity is less than 1, it is a necessity good. If the elasticity

of demand is greater than 1, it is a luxury good or a superior good.

A zero income elasticity (or inelastic) demand occurs when an increase inincome is not associated with a change in the demand of a good. These

would be sticky goods.

Mathematical definition

More formally, the income elasticity of demand, , for a given Marshallian

demand function for a good is

or alternatively:
http://en.wikipedia.org/wiki/Elasticity_(economics)http://en.wikipedia.org/wiki/Supply_and_demandhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Normal_goodhttp://en.wikipedia.org/wiki/Luxury_goodhttp://en.wikipedia.org/wiki/Superior_goodhttp://en.wikipedia.org/wiki/Sticky_(economics)http://en.wikipedia.org/wiki/Marshallian_demand_functionhttp://en.wikipedia.org/wiki/Marshallian_demand_functionhttp://en.wikipedia.org/wiki/File:Income_elasticity_of_demand_-_inferior_goods.svghttp://en.wikipedia.org/wiki/Elasticity_(economics)http://en.wikipedia.org/wiki/Supply_and_demandhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Normal_goodhttp://en.wikipedia.org/wiki/Luxury_goodhttp://en.wikipedia.org/wiki/Superior_goodhttp://en.wikipedia.org/wiki/Sticky_(economics)http://en.wikipedia.org/wiki/Marshallian_demand_functionhttp://en.wikipedia.org/wiki/Marshallian_demand_function


11/19

This can be rewritten in the form:

With income I, and vector of prices . Many necessities have an incomeelasticity of demand between zero and one: expenditure on these goods may

increase with income, but not as fast as income does, so the proportion of

expenditure on these goods falls as income rises. This observation for food isknown as Engel's law.

Cross Elasticity of Demand

Here, a change in the price of one good causes a change in the demand for

another.

Cross elasticity of Demand

Proportionate change in purchases of commodity X

for X and Y = ---------------------------------------------------------------Proportionate change in the price of commodity Y

This type of elasticity arises in the case of inter-related goods such as

substitutes and complementary goods.

The two commodities will be complementary, if a fall in the price of Yincreases the demand for X and conversely, if a rise in the price of one

commodity decreases the demand for the other. They will be substitute or

rival goods if a reduction in the price of Y decreases the demand for X, andalso if a rise in price of one commodity (say tea) increases the demand for

the other commodity (say coffee). The cross elasticity of complementarygoods is positive and that between substitutes, it is negative. It should,

however, be remembered that cross elasticity will indicate complementaritiesor rivalry only if the commodities in question figure in the family budget insmall proportions.

Cross elasticity of demand can be used to indicate boundaries between

industries. Goods with high cross elasticity constitute one industry, whereas

goods with low cross elasticity constitute different industries. It is not to be

supposed that cross elasticity represents reciprocal relationship. It is not a
http://en.wikipedia.org/wiki/Necessityhttp://en.wikipedia.org/wiki/Engel's_lawhttp://en.wikipedia.org/wiki/Necessityhttp://en.wikipedia.org/wiki/Engel's_law


12/19

two-way street. The cross elasticity of a tea with respect to coffee is not

the same as that of coffee with respect to tea. The tastes of the consumer,

his money income and all prices except of the commodity Y are assumed to

remain constant.

Substitute good

A substitute good, in contrast to a complementary good, is a good with a positive crosselasticity of demand.This means a good's demand is increased when the price of anothergood is increased. Conversely, the demand for a good is decreased when the price of another

good is decreased. If goods A and B are substitutes, an increase in the price of A will result in a

leftward movement along the demand curve of A and cause the demand curve for B to shift

out. A decrease in the price of A will result in a rightward movement along the demand curve of

A and cause the demand curve for B to shift in.

Substitute goods exhibit a positive cross elasticity of demand: as the price ofgood Y rises, the demand for good X rises

Examples

Classic examples of substitute goods include margarine and butter, or

petroleum and natural gas (used for heating or electricity). The fact that one

good is substitutable for another has immediate economic consequences:insofar as one good can be substituted for another, the demand for the two

kinds of good will be bound together by the fact that customers can trade off

one good for the other if it becomes advantageous to do so.

Increase in price

An increase in price (ceteris paribus) will result in an increase in demand for

its substitutes goods. Thus, economists can predict that a spike in the cost ofwood will likely mean increased business for bricklayers, or that falling

cellular phone rates will mean a fall-off in business for public pay phones.
http://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Good_(economics)http://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_increase_demandhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_increase_demandhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_decrease_demandhttp://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Margarinehttp://en.wikipedia.org/wiki/Butterhttp://en.wikipedia.org/wiki/Petroleumhttp://en.wikipedia.org/wiki/Natural_gashttp://en.wikipedia.org/wiki/Electricityhttp://en.wikipedia.org/wiki/Demandhttp://en.wikipedia.org/wiki/Pricehttp://en.wikipedia.org/wiki/Ceteris_paribushttp://en.wikipedia.org/wiki/File:Cross_elasticity_of_demand_substitutes.svghttp://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Good_(economics)http://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_increase_demandhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_increase_demandhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_decrease_demandhttp://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Margarinehttp://en.wikipedia.org/wiki/Butterhttp://en.wikipedia.org/wiki/Petroleumhttp://en.wikipedia.org/wiki/Natural_gashttp://en.wikipedia.org/wiki/Electricityhttp://en.wikipedia.org/wiki/Demandhttp://en.wikipedia.org/wiki/Pricehttp://en.wikipedia.org/wiki/Ceteris_paribus


13/19

Different types

It is important to note that when speaking about substitute goods we arespeaking about two different kinds of goods; so the "substitutability" of one

good for another is always a matter of degree. One good is a perfect

substitute for another only if it can be used in exactly the same way. In

that case the utility of a combination is an increasing function of the sum ofthe two amounts, and theoretically, in the case of a price difference, therewould be no demand for the more expensive good.

In microeconomics, two types of substitutes are being distinguished. Good X

is said to be gross substitute of goodYif

Goods X and Y are said to be net substitutes if

where U= U(X,Y) is a utility function.

Perfect and Imperfect substitutes

Indifference curve for perfect substitutes
http://en.wikipedia.org/wiki/Utilityhttp://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/File:Indifference-curves-perfect-substitutes.svghttp://en.wikipedia.org/wiki/Utilityhttp://en.wikipedia.org/wiki/Indifference_curve


14/19

Perfect substitutes may alternatively be characterized as goods having a

constant marginal rate of substitution. Alternative types of soft drinks arecommonly used as an example of perfect substitutes. As the price of Coca

Cola rises, consumers would be expected to substitute Pepsi in equalquantities, i.e., total cola consumption would hold constant. Also, blank

media such as a writable Compact Discs from alternate manufacturers would

be perfect substitutes. If one manufacturer raises the price of its CDs,consumers would be expected to switch to a lower cost manufacturer.

Imperfect substitutes exhibit variable marginal rates of substitution alongthe consumer indifference curve.

Perfect Competition

One of the requirements for perfect competition is that the products of

competing firms should be perfect substitutes. When this condition is notsatisfied, the market is characterized by product differentiation.

Good Substitution

Substitute goods exhibit no complementarities, as in a complementary good.

In other words, good substitution is an economic concept where two goods

are of comparable value. Potatoes from different farms are an example; ifthe price one farm's potatoes goes up, people will stop buying them and buy

the other farm's instead, ceteris paribus (assuming that potatoes from

different farms are ho

Complementary good

Complementary goods exhibit a negative cross elasticity of demand: as the price ofgood Y rises, the demand for good X falls.
http://en.wikipedia.org/wiki/Marginal_rate_of_substitutionhttp://en.wikipedia.org/wiki/Coca_Colahttp://en.wikipedia.org/wiki/Coca_Colahttp://en.wikipedia.org/wiki/Pepsihttp://en.wikipedia.org/wiki/Compact_Dischttp://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Perfect_competitionhttp://en.wikipedia.org/wiki/Product_differentiationhttp://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Ceteris_paribushttp://en.wikipedia.org/wiki/Homogenoushttp://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/File:Cross_elasticity_of_demand_complements.svghttp://en.wikipedia.org/wiki/Marginal_rate_of_substitutionhttp://en.wikipedia.org/wiki/Coca_Colahttp://en.wikipedia.org/wiki/Coca_Colahttp://en.wikipedia.org/wiki/Pepsihttp://en.wikipedia.org/wiki/Compact_Dischttp://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Perfect_competitionhttp://en.wikipedia.org/wiki/Product_differentiationhttp://en.wikipedia.org/wiki/Complementary_goodhttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Ceteris_paribushttp://en.wikipedia.org/wiki/Homogenoushttp://en.wikipedia.org/wiki/Cross_elasticity_of_demand


15/19

A complementary good, in contrast to a substitute good, is a good with anegative cross elasticity of demand.[1] This means a good's demand is increased

when the price of another good is decreased. Conversely, the demand for a good isdecreased when the price of another good is increased.[2] If goods A and B are

complements, an increase in the price of A will result in a leftward movement alongthe demand curve of A and cause the demand curve for B to shift in; less of each

good will be demanded. A decrease in price of A will result in a rightward movement

along the demand curve of A and cause the demand curve B to shift outward; moreof each good will be demanded.

Example

Supply and demand of hotdogs

An example of this would be the demand for hotdogs and hotdog buns. The supplyand demand of hotdogs is represented by the figure at the right with the initialdemand D1. Suppose that the initial price of hotdogs is represented by P1 with aquantity demanded of Q1. If the price of hotdog buns were to decrease by some

amount, this would result in a higher quantity of hotdogs demanded. This higherquantity demanded would cause the demand curve to shift outward to a new

position D2. Assuming a constant supply S of hotdogs, the new quantity demandedwill be at D2 with a new price P2.

Other examples include:

Peanut butter and jelly

Printers and ink cartridges

DVD players and DVDs

Computer hardware and computer software

Perfect complement
http://en.wikipedia.org/wiki/Substitute_goodhttp://en.wikipedia.org/wiki/Good_(economics)http://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Complementary_good#cite_note-0http://en.wikipedia.org/wiki/Complementary_good#cite_note-1http://en.wikipedia.org/wiki/Demand_curve#Changes_that_decrease_demandhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_increase_demandhttp://en.wikipedia.org/wiki/Hotdogshttp://en.wikipedia.org/wiki/Hotdog_bunhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_increase_demandhttp://en.wikipedia.org/wiki/File:Supply-and-demand.svghttp://en.wikipedia.org/wiki/Substitute_goodhttp://en.wikipedia.org/wiki/Good_(economics)http://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Complementary_good#cite_note-0http://en.wikipedia.org/wiki/Complementary_good#cite_note-1http://en.wikipedia.org/wiki/Demand_curve#Changes_that_decrease_demandhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_increase_demandhttp://en.wikipedia.org/wiki/Hotdogshttp://en.wikipedia.org/wiki/Hotdog_bunhttp://en.wikipedia.org/wiki/Demand_curve#Changes_that_increase_demand


16/19

Indifference curve for perfect complements

A perfect complement is a good that has to be consumed with another

good. The indifference curve of a perfect complement will exhibit a rightangle, as illustrated by the figure at the right.[3] Few goods in the real world

will behave as perfect complements.[4] One example is a left shoe and a

right; shoes are naturally sold in pairs, and the ratio between sales of left

and right shoes will never shift noticeably from 1:1 - even if, for example,someone is missing a leg and buys just one shoe.

The degree of complementarity, however, does not have to be mutual; it can

be measured by cross price elasticity of demand. In the case of video

games, a specific video game (the complement good) has to be consumedwith a video game console (the base good). It does not work the other way:

a video game console does not have to be consumed with that game.

Luxury good

In economics, a luxury good is a good for which demand increases more

than proportionally as income rises, in contrast to a "necessity good", forwhich demand is not related to income.

Luxury goods are said to have high income elasticity of demand: as

people become wealthier, they will buy more and more of the luxurygood. This also means, however, that should there be a decline in income

its demand will drop. Income elasticity of demand is not constant withrespect to income, and may change sign at different levels of income.

That is to say, a luxury good may become a normal good or even an

inferior good at different income levels, e.g. a wealthy person stopsbuying increasing numbers of luxury cars for his automobile collection to

start collecting airplanes (at such an income level, the luxury car wouldbecome an inferior good)

The Mercedes-Benz S-class is an example of a luxury good.

Defining luxury
http://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Complementary_good#cite_note-2http://en.wikipedia.org/wiki/Complementary_good#cite_note-3http://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Good_(economics)http://en.wikipedia.org/wiki/Demandhttp://en.wikipedia.org/wiki/Incomehttp://en.wikipedia.org/wiki/Necessity_goodhttp://en.wikipedia.org/wiki/Income_elasticity_of_demandhttp://en.wikipedia.org/wiki/Normal_goodhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Mercedes-Benzhttp://en.wikipedia.org/wiki/File:Indifference-curves-perfect-complements.svghttp://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Complementary_good#cite_note-2http://en.wikipedia.org/wiki/Complementary_good#cite_note-3http://en.wikipedia.org/wiki/Cross_elasticity_of_demandhttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Good_(economics)http://en.wikipedia.org/wiki/Demandhttp://en.wikipedia.org/wiki/Incomehttp://en.wikipedia.org/wiki/Necessity_goodhttp://en.wikipedia.org/wiki/Income_elasticity_of_demandhttp://en.wikipedia.org/wiki/Normal_goodhttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Mercedes-Benz


17/19

The concept of luxury has been present in various forms since the beginning

of civilization. Its role was just as important in ancient western and easternempires as it is in modern societies.[1] With the clear differences between

social classes in earlier civilizations, the consumption of luxury was limited tothe elite classes. It also meant the definition of luxury was fairly clear.

Whatever the poor cannot have and the elite can was identified as luxury.

With increasing democratization, several new product categories werecreated within the luxury markets which were aptly called accessible

luxury or mass luxury. This kind of luxury specifically targeted the middleclass (or what is sometimes termed as aspiring class). As luxury penetrated

into the masses, defining luxury has become ever so difficult.

In contemporary marketing usage, Prof. Bernard Dubois defines luxury as aspecific (i.e. higher-priced) tier of offer in almost any product or service

category. However, despite the substantial body of knowledge accumulatedduring the past decades, researchers still havent arrived on a common

definition of luxury. Many other attempts have been made to define luxury

using the price-quality dimension stating higher priced products in anycategory is luxury. Similarly, researchers have used the uniqueness aspects

of luxury too. Prof. Jean-Noel Kapferer, takes an experiential approach anddefines luxury as items which provide extra pleasure by flattering all senses

at once. Several other researchers focus on exclusivity dimension and argue

that luxury evokes a sense of belonging to a certain elite group.

Socioeconomic significance

18 or more karatgold jewelry is an example of a luxury good.

Several manufactured products attain the status of "luxury goods" due totheir design, quality, durability or performance that are remarkably superiorto the comparable substitutes. Thus, virtually every category of goods

available on the market today includes a subset of similar products whose

"luxury" is marked by better-quality components and materials, solidconstruction, stylish appearance, increased durability, better performance,

advanced features, and so on. As such, these luxury goods may retain orimprove the basic functionality for which all items of a given category are

originally designed.
http://en.wikipedia.org/wiki/Luxury_good#cite_note-0http://en.wikipedia.org/wiki/Carat_(purity)http://en.wikipedia.org/wiki/Goldhttp://en.wikipedia.org/wiki/File:Armani.jpghttp://en.wikipedia.org/wiki/Luxury_good#cite_note-0http://en.wikipedia.org/wiki/Carat_(purity)http://en.wikipedia.org/wiki/Gold


18/19

There are also goods that are perceived as luxurious by the public simply

because they play a role ofstatus symbols as such goods tend to signify thepurchasing power of those who acquire them. These items, while not

necessarily being better (in quality, performance, or appearance) than theirless expensive substitutes, are purchased with the main purpose of

displaying wealth or income of their owners. These kinds of goods are the

objects of a socio-economic phenomenon called conspicuous consumptionand commonly include luxury vehicles, expensive watches and jewelry,

designer clothing, yachts, and large residences, urban mansions and countryhouses.

Normal good

In economics, normal goods are any goods for which demand increases

when income increases and falls when income decreases but price remainsconstant, i.e. with a positive income elasticity of demand.[1][2] The term does

not necessarily refer to the quality of the good.

Depending on the indifference curves, the amount of a good bought caneither increase, decrease, or stay the same when income increases. In the

diagram below, good Y is a normal good since the amount purchasedincreases from Y1 to Y2 as the budget constraint shifts from BC1 to the

higher income BC2. Good X is an inferior good since the amount boughtdecreases from X1 to X2 as income increases.

Inferior good

In consumer theory, an inferior good is a good that decreases in demandwhen consumer income rises, unlike normal goods, for which the opposite is

observed. Normal goods are those for which consumers' demand increases
http://en.wikipedia.org/wiki/Status_symbolhttp://en.wikipedia.org/wiki/Wealthhttp://en.wikipedia.org/wiki/Incomehttp://en.wikipedia.org/wiki/Conspicuous_consumptionhttp://en.wikipedia.org/wiki/Luxury_vehiclehttp://en.wikipedia.org/wiki/Watcheshttp://en.wikipedia.org/wiki/Jewelryhttp://en.wikipedia.org/wiki/Designer_clothinghttp://en.wikipedia.org/wiki/Yachthttp://en.wikipedia.org/wiki/Mansionhttp://en.wikipedia.org/wiki/Country_househttp://en.wikipedia.org/wiki/Country_househttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Good_(economics)http://en.wikipedia.org/wiki/Demand_(economics)http://en.wikipedia.org/wiki/Income_elasticity_of_demandhttp://en.wikipedia.org/wiki/Normal_good#cite_note-0http://en.wikipedia.org/wiki/Normal_good#cite_note-1http://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Budget_constrainthttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Consumer_theoryhttp://en.wikipedia.org/wiki/Normal_goodhttp://en.wikipedia.org/wiki/File:Inferior_good.pnghttp://en.wikipedia.org/wiki/Status_symbolhttp://en.wikipedia.org/wiki/Wealthhttp://en.wikipedia.org/wiki/Incomehttp://en.wikipedia.org/wiki/Conspicuous_consumptionhttp://en.wikipedia.org/wiki/Luxury_vehiclehttp://en.wikipedia.org/wiki/Watcheshttp://en.wikipedia.org/wiki/Jewelryhttp://en.wikipedia.org/wiki/Designer_clothinghttp://en.wikipedia.org/wiki/Yachthttp://en.wikipedia.org/wiki/Mansionhttp://en.wikipedia.org/wiki/Country_househttp://en.wikipedia.org/wiki/Country_househttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Good_(economics)http://en.wikipedia.org/wiki/Demand_(economics)http://en.wikipedia.org/wiki/Income_elasticity_of_demandhttp://en.wikipedia.org/wiki/Normal_good#cite_note-0http://en.wikipedia.org/wiki/Normal_good#cite_note-1http://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Budget_constrainthttp://en.wikipedia.org/wiki/Inferior_goodhttp://en.wikipedia.org/wiki/Consumer_theoryhttp://en.wikipedia.org/wiki/Normal_good


19/19

when their income increases. [2] Inferiority, in this sense, is an observable

fact relating to affordability rather than a statement about the quality of thegood. As a rule, too much of a good thing is easily achieved with such goods,

and as more costly substitutes that offer more pleasure or at least varietybecome available, the use of the inferior goods diminishes.

Good Y is a normal good since the amount purchased increases from Y1 toY2 as the budget constraint shifts from BC1 to the higher income BC2. Good

X is an inferior good since the amount bought decreases from X1 to X2 as

income increases.

Depending on consumer or market indifference curves, the amount of a

good bought can either increase, decrease, or stay the same when incomeincreases.

Examples

Tahitian Treat: A low-cost carbonated fruit punch beverage.

Thirst Rockers: A Kroger brand of imitation juice beverage in gallonmilk jugs.

"Valu-Time" Ice Cream: Ice cream sold in 2.5 gallon plastic pails atgrocery stores, with an emphasis on value and quantity as opposed to

quality or advertising.

Cosmic brownies: Low cost cakes resembling small browniesmanufactured by the Little Debbies company.

Faygo Brand soda: A low cost non-advertised soda pop manufactured

in Detroit, MI.
http://en.wikipedia.org/wiki/Inferior_good#cite_note-1http://en.wikipedia.org/wiki/Indifference_curveshttp://en.wikipedia.org/wiki/Tahitian_Treathttp://en.wikipedia.org/w/index.php?title=Thirst_Rockers&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=%22Valu-Time%22_Ice_Cream&action=edit&redlink=1http://en.wikipedia.org/wiki/Cosmic_brownieshttp://en.wikipedia.org/wiki/McKee_Foodshttp://en.wikipedia.org/wiki/Faygohttp://en.wikipedia.org/wiki/File:Inferior_good.pnghttp://en.wikipedia.org/wiki/Inferior_good#cite_note-1http://en.wikipedia.org/wiki/Indifference_curveshttp://en.wikipedia.org/wiki/Tahitian_Treathttp://en.wikipedia.org/w/index.php?title=Thirst_Rockers&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=%22Valu-Time%22_Ice_Cream&action=edit&redlink=1http://en.wikipedia.org/wiki/Cosmic_brownieshttp://en.wikipedia.org/wiki/McKee_Foodshttp://en.wikipedia.org/wiki/Faygo

Final ED Word Document

Documents

Transcript of Final ED Word Document