Question

BSE 2211 Microeconomics Exam 2 3. Answer the following short answer questions a) What is Income Elasticity of Demand? b) How is Income Elasticity of Demand related to the concept of normal and inferior goods? c) What is Cross-Elasticity of Demand? d) How is Cross-Elasticity of Demand related to the concept of complementary and substitute goods?

Answer 1

Part (a) Income elasticity of demand measures the responsiveness of the quantity demanded for a good or service to a change in income.

og aQY &Y = JY JYQ Where, aQ is change in demand ay is change in income

Part (b)

Positive Income Elasticity of Demand refers to a situation when the demand for a product increases with increase in consumer’s income and decreases with decrease in consumer’s income. The income elasticity of demand is positive for normal goods.

Negative Income Elasticity of Demand refers to a situation when the demand for a product increases with decrease in consumer’s income and decreases with increase in consumer’s income. The income elasticity of demand is negative for inferior goods.

Part (c)

Cross elasticity of demand measures responsiveness of quantity demanded for good X to changes in price of good Y.  It is the ratio of proportionate change in the quantity demanded of X to a given proportionate change in the price of the related commodity Y.

Cross elasticity of demand = By on = əPy * Qx 0Qx

Part (d)

When goods X and Y are substitute of each other i.e. goods X and Y can be used in place of each other, then cross elasticity of demand is positive. Therefore, when price of good Y increases , the demand for good X also increases. Similarly, when price of good Y falls the demand for good X also falls

When goods X and Y are complements i.e. both the goods should be used together and cannot be used separately, then cross elasticity of demand is negative.Therefore. a fall in price of good Y increases the demand for good X and rise in price of good Y leads to fall in demand of good X.