2 What is the income elasticity of demand How can it be used

2. What is the income elasticity of demand? How can it be used to determine whether a good is a normal good or an nferior good? What is the cross-price elasticity of demand? How can it be used to determine whether two goods are substitutes or compliments?

Solution

Income elasticity of demand is defined as the change in quantity consumed for a change in consumer income. It is the response shown by a customer towards purchasing a good when his income increases.

Normal good: When a person’s income increases the consumption of good increases

Inferior good: Here when income increases the consumption decreases as the consumer would prefer to consume other good

Cross price elasticity of demand: It is the change in consumption of a good when the price of other good changes. It is used to understand how sensitive a good for a change in price of the other good.

So, when the increase in price of good creates increased demand for other good, the cross price elasticity of demand is positive indicating substitutes

When the increase in price of good creates decreased demand for other good, the cross price elasticity of demand is negative indicating complementary goods