Other elasticities
Elasticity applies to any responsiveness: of demand to income or other prices, and of supply to price.
Income elasticity of demand
Income elasticity measures how quantity demanded responds to income: % change in quantity / % change in income. It is positive for normal goods and negative for inferior goods. Goods with income elasticity above 1 are luxuries, taking a bigger share of spending as people get richer; those between 0 and 1 are necessities.
Uses of income elasticity
Firms use income elasticity to forecast sales as economies grow: demand for air travel and restaurant meals rises faster than income, while demand for basic foods rises slowly. During recessions, sales of inferior goods such as discount store brands can rise.
Cross-price elasticity
Cross-price elasticity measures how demand for one good responds to the price of another: % change in quantity of good A / % change in price of good B. It is positive for substitutes (Coke and Pepsi) and negative for complements (cars and petrol). Near zero means the goods are unrelated.
Competition policy
Competition authorities use cross-price elasticities to decide which products compete. If a price rise in one brand sends many customers to another, they are in the same market. This matters when judging whether a merger would give a firm too much market power.
Price elasticity of supply
Price elasticity of supply measures how quantity supplied responds to price: % change in quantity supplied / % change in price. Supply is more elastic when production can expand easily, when inputs are readily available, when goods can be stored, and over longer periods.
Supply in the short and long run
In the very short run, supply may be almost perfectly inelastic: a fishing boat's catch for the day is fixed. Over months, firms can hire workers and add shifts; over years, they can build factories and new firms can enter. Housing supply in crowded cities is often inelastic because land and planning permission are limited.
Elasticity and tax incidence
When demand is inelastic relative to supply, buyers bear most of a tax because they keep buying anyway. When supply is inelastic, sellers bear most. Taxes on goods with inelastic demand and supply create smaller deadweight losses, because quantities change little.
Worked example
When average incomes rise 5%, spending on foreign holidays rises 12% and spending on potatoes falls 2%. Income elasticity for holidays is 12/5 = 2.4, a luxury; for potatoes it is -2/5 = -0.4, an inferior good.
Key takeaways
Income elasticity separates normal goods (positive), luxuries (above 1), and inferior goods (negative). Cross-price elasticity is positive for substitutes and negative for complements, guiding competition policy. Supply elasticity rises with flexibility and time. Tax burdens fall mainly on the less elastic side, and deadweight loss is smaller when elasticities are low.
Flashcard
%change in Q / %change in income
Check your understanding
When the price of petrol rises 10%, demand for large cars falls 5%. The cross-price elasticity is: