(a) Illustrating with examples, explain the concepts of price elasticity of demand, income elasticity of demand and cross elasticity of demand.
Income elasticity of demand measures the responsiveness of demand to a change in income, ceteris paribus. It is the percentage change in demand for a good resulting from a percentage change in income, ceteris paribus. When income changes with other price or non-price factors, such as income, remaining unchanged, income elasticity of demand measures how much to which demand will change, ceteris paribus.
Income elasticity of demand that is negative refers to inferior goods which are of lower quality and are cheaper alternatives. An increase of income will result to a fall in demand of these items. As people’s incomes increase, the demand for such inferior goods will decrease as people now have the ability to purchase goods of higher quality. This will result the demand curve for the inferior goods to shift leftwards. On the other hand, the income elasticity of demand that is positive (between 0 and 1) refers to normal necessity goods. As income increases, basic necessities such as bread, will only rise a little. The demand for these items rises less than proportionately with a change in income as we have a limited need to consume additional quantities of basic or necessary goods. Therefore, the demand curve will only shift rightwards by a little. Finally, income elasticity of demand that is positive (more than 1) implies to normal luxurious goods. When income increases, the demand for luxury goods such as cars, rises more than proportionately to a change in income as consumers have the confidence and the purchasing power to buy these goods. Hence, the demand curve will shift more significantly to the right.
However, the income level of consumers is another factor which affects the income elasticity of demand. While the income elasticity of demand for basic necessities is less than 1, the income elasticity of...
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