Lecture2

# Lecture2 - LECTURE #2: Income Elasticity of Demand (eI)...

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LECTURE #2: Income Elasticity of Demand (e I ) Definition: e I = % in Q = δ Q · _I_ I Q % in I δ I If e I > 0 then we have a normal good . e I > 1 means a luxury good. 1 means a necessity e I < 1 means a necessity. If e I < 0 then we have an inferior good . Engel Curves : An Engel curve relates changes in income to changes in quantity demanded. For example, for a normal good, as income increases so too does quantity demanded. On the other hand, for an inferior good, as income increases the quantity demanded of the good decreases.

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Engel Law states that, as income increases, the percentage of income spent on certain foods declines. In general, it has been empirically observed that as income rises, some goods that were normal become inferior.
Cross Price Elasticity of Demand (e XY ) Definition: e XY = % in Q X = δ Q X · _P Y _ P % in P Y δ P Y Q X If e XY > 0, then good X and good Y are substitutes. Y < 0, then good X and good Y are complements. xample: e XY 0, then good X and good Y are complements. e XY = 0, then good X and good Y are unrelated. Example: Substitute: Water skis (Y)… P skis Q boards , so… e Y = % in Q oards = + = + Wakeboards (X) XY boards _ _ % in P skis + Complement: Life Jackets (Y)… P jacket Q boards , so… e XY = % in Q boards = _- _ = - % in P jackets +

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The magnitude of the cross price elasticity measures the degree of substitutability (+) or complementarity (-). This is often quite useful when conducting market studies or when nalyzing certain policy effects analyzing certain policy effects. Derivation of Total Revenue (TR) and Marginal Revenue (MR) t A the price is so high that nothing is sold (TR = 0). At B, the price is At A the price is so high that nothing is sold (TR 0). At B, the price is zero so TR = 0. (Total Revenue = price x quantity OR TR = PQ) Total revenue at any price-quantity combination can be represented as a rectangle under the demand curve. This reaches a maximum (in rms of area) at the midpoint of a straight- ne demand curve terms of area) at the midpoint of a straight line demand curve. The total revenue curve thus rises from zero to some maximum (at the midpoint of the straight-line demand curve) and then returns back to zero. Marginal revenue (MR) is the change in Total revenue as a result of a change in the quantity sold. R = R / = the slope of the TR curve MR = TR / Q = the slope of the TR curve. As quantity increases, the slope of the TR curve (MR) gets flatter (i.e. MR is falling) until it flattens completely where TR is maximized and then turns downward sloping (i.e. MR becomes negative). Thus, MR crosses the Q-axis where TR is maximized.
These are the relationships that we have developed so far… P TR = 0 TR is maximized. MR is zero. i one. e p so e Q TR = 0 In this graph, we are representing the case where price is falling and quantity demanded is rising.

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## This note was uploaded on 03/31/2011 for the course ECON 201 taught by Professor Vandewaal during the Fall '09 term at Waterloo.

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Lecture2 - LECTURE #2: Income Elasticity of Demand (eI)...

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