© 1999-2020, Douglas A.Ruby (05-19_2020)

On the demand-side of the market, elasticities can be calculated for any of the relevant exogenous variables. In all cases, this calculation measures the percentage change in quantity demanded relative to a percentage change in one of the exogenous variables.

Income elasticities measure the response in quantity demanded to a change in consumer income. In this case, the corresponding elasticity may be positive for normal goods, negative for inferior goods, or equal to zero for income neutral goods. This elasticity is computed as follows:

η_{M}= (%ΔQ^{D})/(%ΔM)

=(ΔQ/Q)

(ΔM/M)

If both numerator and denominator are of the same sign (both increase or both
decrease) then the corresponding good or service is a *normal good*. If numerator and
denominator are opposite in sign (one increases as the other decreases), then the
good is an *inferior good*. Finally if the value of the numerator is zero (quantity
demanded does not change with income), then the good is *income neutral*. The table
below summarizes these results:

Income Elasticity |
Type of Good |

h_{M} < 0 |
An Inferior Good |

h_{M} = 0 |
An Income-Neutral Good |

0 < h_{M} < 1.0 |
A Normal (necessity) Good |

h_{M} > 1.0 |
A Normal (luxury) Good |

Cross-Price elasticity of demand measures the response of quantity demanded of one good to changes in the price of a second (related) good. This elasticity is computed as follows:

η_{xy}= (%ΔQ_{x}^{D})/ (%ΔP_{y})

If the two goods are substitutes we would expect the following:

P_{y},Q_{y}^{D}; Q_{x}^{D}

In this case the price of good-y and the quantity demanded of good-x move in the same direction and thus the cross-price elasticity would be positive.

If the two goods are complements, then the relationship between the price of one good and quantity demanded of the other would be:

P_{y}↑,Q_{y}^{D}; Q_{x}^{D}↓

Where in this case the price of good-y and quantity demanded of good-x move in opposite directions. The corresponding cross-price elasticity would be negative.

Finally if changes in the price of one good has no effect on the quantity demanded of the other, then the cross-price elasticity would be zero and the two goods are unrelated. The following table summarizes these results:

Cross-Price Elasticity |
Goods 'x' & 'y' are: |

h_{xy} < 0 |
Complement Goods |

h_{xy} = 0 |
Unrelated Goods |

h_{xy} > 0 |
Substitute Goods |

The following demand equation represents a non-linear relationship between quantity demanded and market price.

Q_{x}^{D}=AP_{x}^{α}

This expression is a valid demand relationship *if* the parameter α is strictly less than zero. In addition, the coefficient '**A**',
in this equation, is a measure all of the other exogenous influences on demand (income, tastes and preferences, price of related goods, number of
consumers in the market). Changes in any of these exogenous variables will affect the value of this coefficient.

Noting that the price-elasticity of demand may be written as:

η_{p}= (%ΔQ) / (%ΔP)

=(ΔQ/Q)

(ΔP/P)

=(DQ) (P)

(ΔP) (Q)

In this last expression the (ΔQ / ΔP) term represents the slope of the demand equation. Thus, if we differentiate the non-linear demand equation given above and substitute, we have the following:

η_{p}= αAP^{α - 1}(P)

(Q)

= (αAP^{α})/Q =α

The parameter (exponent) 'α' is the price elasticity of demand.

A more specific non-linear demand equation (one where many of the exogenous variables are explicitly defined) may be defined as follows:

Q_{x}^{d}= AP_{x}^{α}M^{β}P_{y}^{f}P_{z}^{γ}.

It can be shown (through partial differentiation) that the parameters a,b,f,g all represents various types of elasticity measures. That is:

α = η_{p}--price elasticity of demand,

β = η_{M}--income elasticity of demand,

f = η_{xy}, and

γ = η_{xz}--cross-price elasticities.

Thus if we have the following (estimated) demand equation:

ln(Q_{x}^{D}) = β_{0}+ β_{1}(P_{x}) +β_{2}ln(M) + β_{3}ln(P_{y}) + β_{4}ln(P_{z}) .

ln(Q_{x}^{D}) = 5.01 - 0.75 ln(P_{x}) + 0.50 ln(M) + 1.0 ln(P_{y}) - 1.25 ln(P_{z}) + ε .

Q_{x}^{D}= 150P_{x}^{-0.75}M^{0.50}P_{y}P_{z}^{-1.25}.

we can state that demand for this particular **good-x** is price inelastic
(|η_{p}| < 1.0), a normal good
(0.0 < η_{M} < 1.0),
a substitute with **good-y**
(η_{xy} > 0),
and a complement with **good-z**
(η_{xz} < 0).

**Ski Lift Tickets** Suppose that the equation above represents the estimated demand for lift tickets at
a Colorado resort.

Q^{D}_{tickets}= 150(P_{ticket}^{)-0.75}(M)^{0.50}(P_{tropical resort lodging}) (P_{equipment rentals})^{-1.25}.

P_{tickets} is the own price of a lift ticket, P_{y} the vacation price in a
warmer climate -- *a substitute* and P_{equipment rentals} the rental price of
skiis, boots and poles -- *a complement*. Now suppose that personal income is forcasted to
increase by 3% next year, the price of tropical vacations is reported to fall by 2% and equipment prices
increase by 5%. How much will demand change for lift tickets?

The answer will be: 0.50 x 3% + 1.0 x (-2%) - 1.25 x 5% = -6.75%

The ski resort may want to reduce the price of lift tickets if it's goal is to maintain market share among all resorts.

- Complement (goods)
- Cross-price Elascitity
- Income Elasticity
- Income-neutral (goods)
- Inferior Goods
- Normal Goods
- Substitute (goods)