Essay: Income and Cross elasticity of demand; an Example

Sample Essay

Income elasticity of demand is the measure of the responsiveness of demand for a good or service to a change in income, other things remaining the same (Young, 1987). It is calculated using the following formula:

Income elasticity of demand = % change in quantity demanded / % change in income (Young, 1987)

At I = 2.3, QZ = 4.485

At I = 3.3 (other things remaining the same):

QZ = 1.0 – 2.0PZ + 0.7I + 1.5PA + 0.5PB + 1.5A

QZ = 1.0 – 2.0 (6) + 0.7 (3.3) + 1.5 (6.25) + 0.5 (4.5) + 1.5 (1.5)

QZ = 5.185

Therefore,

Income Elasticity of demand =          (5.185-4.485/4.485) / (3.3-2.3/2.3)

=          1.6

Cross Elasticity of demand is a measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement, other things remaining the same (Lipsey, 1999). We calculate the cross elasticity of demand using the following formula:

Cross Elasticity of demand     =          % change in quantity demanded / % change in price of substitute or complement

The competitive brand of powdered laundry detergent is a substitute, whereas liquid laundry detergent is a complimentary good.

When PA, the price of the competitive brand of powdered laundry detergent, in dollars per box, was $6.25, QZ = 4.485

When PA = 7.25, (other things remaining the same)

QZ = 1.0 – 2.0PZ + 0.7I + 1.5PA + 0.5PB + 1.5A

QZ = 1.0 – 2.0 (6) + 0.7 (2.3) + 1.5 (7.25) + 0.5 (4.5) + 1.5 (1.5)

QZ = 5.985

Therefore,

Cross Elasticity of demand     =          (5.985-4.485/4.485) / (7.25-6.25/6.25)

=          2.1

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