Elasticity of demand is the relationship between the demands for a product with respect to its price. Generally, when the demand for a product is high, the price of the product decreases. When demand decreases, prices tend to climb. Products that exhibit the characteristics of elasticity of demand are usually cars, appliances and other luxury items. Items such as clothing, medicine and food are considered to be necessities. Essential items usually possess inelasticity of demand. When this occurs prices do not change significantly.
“The Cross-price elasticity of demand measures the rate of response of quantity demanded of one good, due to a price change of another good” (Economics.about.com, 2013). When two similar products are present they are considered to be substitutes for each other. For example, say you have Coke and Pepsi. When the price of Coke rises so will the increased demand for Pepsi and other like products. This is considered to be a positive relationship. The relationship is negative when you have two products that complement each other. For example, say the price of a car increases. When price escalates the demand for tires, its complementary product, will decrease.
Income elasticity is a way that economists measure the level that people act in response to changes in their income that may effect the consumer purchasing more or less of a product. This form of measurement helps to classify products as inferior or normal. A normal good can be described as a product that increases in demand at the same time people purchasing their product have an increase in their income. Even though both are increasing, income will not increase as fast as demand. Income elasticity of demand is positive at that point.
Income elasticity of demand is measured less than one. An inferior good is a good that is consumed less due to an increase in the buyer’s income. For example, if the price of ramen noodles increased, consumers may choose to buy other products such as regular or whole wheat pastas or soups. In this case, the ramen noodles would be considered the inferior good. Even though college students love ramen noodles for several reasons, I’m pretty sure that if the price increased that students would alter their choices leaving the ramen noodles as the inferior good. Income elasticity of demand for an inferior good is measured at less than zero.
The elasticity of demand measures the buyer’s reaction to price as its changing. “Economists measure the degree to which demand is price elastic or inelastic with the coefficient E d, defined as E d = percentage change in quantity demanded of product X/ percentage change in price of product X” (McConnell, C. 2011). Therefore, Ed=∆Qd/∆Pd. When elasticity of demand is measured less than one, demand is considered to be inelastic. The coefficient in an inelastic range is less than one. When this takes place the percentage change in price is more than the percentage change in quantity. It can be said that when inelastic demand is present that quantity becomes less effected by price changing.
When elasticity of demand is measured more than one demand is classified as being elastic. At this rate the percentage change in price is less than the percentage change in quantity demanded. Therefore, E d = ∆Qd is greater/ ∆Pd is less. The coefficient in an elastic range is more than one. Elastic demand is unlike inelastic demand because it is greatly impacted by price changing. Even a small price increase can change the effect for the demand of a product. At this point quantity becomes more reactive to price changing.
In a unit-elastic demand range the percentage in change in quantity is equal to the percentage change in price. Therefore, a change in the price will have the exact same change as the quantity demanded. When unit-elastic demand is present the coefficient is equal to one.
Cross-price elasticity can be defined as “the relative response of demand to changes in the price of another good, or the percentage change in demand for one good due to percentage change in the price of another good” (Amosweb.com. 2013). To calculate the coefficient of cross-price elasticity you divide the percentage in quantity demanded of product A by the percentage change in price of product B. When this formula generates a negative result the good is considered to be a complement. Lets say you have two products that are complements; an increase in the demand for the first product will cause the complementary product to increase in the quantity demanded. The coefficient of complement has a negative result when the price of product A increases causing demand for product B to change. A substitute is the opposite of a complement. A substitute would have a positive value for cross elasticity. When the demand for product A increases and the price of product B also increases this is classified as a substitute good.