In addition to price elasticities of supply and demand, economists frequently refer to other elasticity measurements. Income elasticity of demand measures the responsiveness of people's purchases to changes in income. It is defined as
Income Elasticity = (percentage change in amount bought) divided by (percentage change in income)
Income elasticity measures whether a good is a normal or an inferior good. A product is a normal good when its income elasticity is positive, meaning that higher income causes people to purchase more of the product. For an inferior good, income elasticity is negative because an increase in income causes people to buy less of the product.
Cross-price elasticity, often simply called just cross-elasticity, measures whether goods are substitutes or complements. It looks at the response of people in buying one product when the price of another product changes. The formula for cross-price elasticity is
Cross-Price Elasticity = (percentage change in amount of A bought) divided by (percentage change in price of B).
If goods are complements, cross-price elasticity will be negative. For example, if the price of gasoline rises, the sales of large cars will decline. The positive change in the denominator (bottom) is matched with a negative change in the numerator (top) of the equation. The result is therefore negative. If cross-price elasticity is positive, B is a substitute for A. For example, sales of Coke will fall if the price of Pepsi falls because some Coke drinkers will switch from Coke to Pepsi.
Next we shift gears and see how revenue and the demand curve are related.
Copyright Robert Schenk