Egt 1 Task 1

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Economics Revision Focus: 2004

AS Economics
Income Elasticity and Cross-price
Elasticity

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Income Elasticity and Cross-price Elasticity

Revision Focus on Income Elasticity and Cross-price Elasticity (AS) AS Syllabus Requirements
Income elasticity and cross-price elasticity of demand
Candidates should understand the significance of cross price and income elasticities of demand in influencing the extent of any fluctuations in market prices and in affecting the inter-relationships between markets

Income elasticity of demand (Yed)
How sensitive is the demand for a product to a change in the real incomes of consumers? We use income elasticity of demand to measure this. The results are important since the values of income elasticity tell us something about the nature of a product and how it is perceived by consumers. It also affects the extent to which changes in economic growth affect the level and pattern of demand for different goods and services.

Income elasticity of demand measures the relationship between a change in quantity demanded for good X and a change in real income.
The formula for calculating income elasticity is:
% change in quantity demanded DIVIDED BY Percentage change in income Normal Goods
Normal goods have a positive income elasticity of demand so as consumers’ income rises, so more is demanded at each price level i.e. there is an outward shift of the demand curve 1. Normal necessities have an income elasticity of demand of between 0 and +1 for example, if income increases by 10% and the demand for fresh fruit increases by 4% then the income elasticity is +0.4. Demand is rising less than proportionately to income. 2. Luxuries have an income elasticity of demand > +1 i.e. the demand rises more than proportionate to a change in income – for example a 8% increase in income might lead to a 16% rise in the demand for restaurant meals. The income elasticity of demand in this example is +2.0. Demand is highly sensitive to (increases or decreases in) income. Inferior Goods

Inferior goods have a negative income elasticity of demand. Demand falls as income rises. Typically inferior goods or services tend to be products where there are superior goods available if the consumer has the money to be able to buy it. Examples include the demand for cigarettes, low-priced own label foods in supermarkets and the demand for council-owned properties. The income elasticity of demand is usually strongly positive for Wines and spirits

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Income Elasticity and Cross-price Elasticity

Consumer durables - audio visual equipment, 3rd generation mobile phones and new kitchens Sports and leisure facilities (including gym membership and sports clubs) In contrast, income elasticity of demand is lower (but still positive) for Staple products such as bread, vegetables and frozen foods

Mass transport (bus and rail)
Beer and takeaway pizza
Product ranges: However the income elasticity of demand varies within a product range. For example the Yed for own-label foods in supermarkets is probably less for the high-value “finest” food ranges that most major supermarkets now offer. You would also expect income elasticity of demand to vary across the vast range of vehicles for sale in the car industry and also in the holiday industry. Long-term changes: There is a general downward trend in the income elasticity of demand for many products, particularly foodstuffs. One reason for this is that as a society becomes richer, there are changes...
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