# Of course all of this applies to the short run in the

• Homework Help
• 250
• 100% (11) 11 out of 11 people found this document helpful

This preview shows page 176 - 180 out of 250 pages.

Of course, all of this applies to the short run. In the long run, firms can build more factories, and (depending on the market structure) new firms can enter the market.Next PageIncome Elasticity of DemandIncome Elasticity of Demand (IEoD)measures the response of QDto a change in consumer income.𝐼𝑛𝑐𝑜𝑚?𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡?𝑜???𝑚𝑎𝑛𝑑=% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛??% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛𝐼𝑛𝑐𝑜𝑚?Income Elasticity of Demand=% Change in QD% Change in Income
Recall from Supply and Demand Review: An increase in income causes an increase in demand for a normal good.Hence, for normal goods, income elasticity > 0.For inferior goods, income elasticity < 0.Next PageExample Problem 8IEoD CalculationLast year, Olivia bought 6 pairs of shoes when her income was \$50,000. This year, her income is \$55,000, and she purchased 8 pairs of shoes. Holding other factors constant and using the midpoint method, it follows that Olivia’s income elasticity of demand is about:𝐼𝐸𝑜?=% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛??% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛𝐼=(?2?1?1+?22(𝐼2𝐼1𝐼1+𝐼22IEoD=% Change in QD% Change in I=(Q2−Q1)÷Q1+Q22(I2−I1)÷I1+I22𝐼𝐸𝑜?=(8−6)÷6+82(55,000−50,000)÷50,000+55,0002=275,00052,500=2×5257×50=3.00IEoD=(8−6)÷6+82(55,000−50,000)÷50,000+55,0002=275,00052,500=2×5257×50=3.00Since IEoD > 0, Olivia regards shoes as a normal good.Next Page
Cross-Price Elasticity of DemandCross-Price Elasticity of Demand (CPEoD)measures the response of demand for one good to changes in the price of another good.𝐶𝑟𝑜𝑠𝑠𝑝𝑟𝑖𝑐?𝐸𝑙𝑎𝑠𝑡. 𝑜???𝑚𝑎𝑛𝑑=% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛???𝑜𝑟𝑔𝑜𝑜𝑑1% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛?𝑜?𝑔𝑜𝑜𝑑2Cross−price Elast. of Demand=% Change in QD for good 1% Change in P of good 2For substitutes, cross-price elasticity > 0(e.g., an increase in price of beef causes an increase in demand for chicken)For complements, cross-price elasticity < 0(e.g., an increase in price of computers causes decrease in demand for software)Next PageExample Problem 9CPEoD CalculationSuppose that when the price of good X falls from \$6 to \$4, the quantity demanded of good Y rises from 30 units to 40 units. Using the midpoint method, the cross-price elasticity of demand is:
𝐶?𝐸𝑜?=% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛??𝑜?𝐺𝑜𝑜𝑑?% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛?𝑜?𝐺𝑜𝑜𝑑?=(?2?1?1+?22(?2?1?1+?22CPEoD=% Change in QD of Good Y% Change in P of Good X=(Q2−Q1)÷Q1+Q22(P2−P1)÷P1+P22𝐶?𝐸𝑜?=(40−30)÷30+402(4−6)÷4+62=1035−25=−57=−0.71CPEoD=(40−30)÷30+402(4−6)÷4+62=1035−25=−57=−0.71Since CPEoD < 0, goods are complements.Next PageExample Problem 10CPEoD CalculationSuppose the cross-price elasticity of demand between peanut butter and jelly is -2.50. This implies that a 20 percent increase in the price of peanut butter will cause the quantity of jelly purchased to:𝐶?𝐸𝑜?=% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛??𝑜?𝐺𝑜𝑜𝑑1% 𝐶ℎ𝑎𝑛𝑔?𝑖𝑛?𝑜?𝐺𝑜𝑜𝑑2=(?2?1?1+?22(?2?1?1+?22