5.3 CrossElasticity and Income Elasticity

CrossElasticity of Demand

• The 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 compliment, other     things remaining the same.

• The     cross elasticity of demand is equal to:

• The     cross elasticity of demand     is positive for substitutes and negative for complements.

Use examples to show the students why thecross elasticity of demand is positive for substitutes and negative forcomplements. For instance, suppose the price of Coke rises. What effect doesthis price hike have on the demand for Pepsi? Students will immediately realizethat the demand for Pepsi increases. So in this case the cross elasticity ofdemand for Pepsi with respect to the price of Coke is calculated by dividingone positive number by another, so the result will be positive. Forcomplements, such as bowling balls and bowling shirts, a price hike for bowlingballs decreases the demand for bowling shirts. So in this case the crosselasticity of demand for bowling shirts with respect to the price of bowlingballs is a negative number divided by a positive number, so the result will benegative.

Income Elasticity of Demand

• The     income elasticity of demand is     a measure of the responsiveness of the demand for a good to a change in     the income, other things remaining the same.

• The     income elasticity of demand is equal to:

• The income elasticity of demand is     positive for normal goods and negative for inferior goods.

qLandMine: Elasticity is a subject that can overwhelmstudents by the many details. Be sure to stress the common features of all thedifferent elasticities. All elasticities measure how strongly people respond toa change in some factor; all elasticities use percentage changes; and allelasticities divide the percentage change in the quantity by the percentagechange in the relevant factor. Of these features, the most important is thefact that elasticities measure responsiveness. Stress this fact and your studentswill find it significantly easier to comprehend all the myriad details.