Define and explain the concept of an income elasticity of demand for a product

Résumé du document

Would you expect the income elasticity for potatoes and DVDs to be large or small? If the supply of oil is price inelastic in the short term, what would you expect the impact of an outwards shift in the demand for oil to be? What might happen in such a situation in the long term? In economics we usually perform a partial equilibrium analysis. Thus, while assuming that all other markets remain constant, we observe only one. We can then observe the changes in supply, prices and demand within this market. However, this is just an indication of the general features of the current trends. It does not define the exact percentage of an increase or decrease in demand. To overcome these shortcomings, economists are now using the tool of elasticity of demand, as it measures the percentage by which demand will alter if there is a change in price, income or supply. Thus there are three types of elasticity. In this document, we will concentrate on the income elasticity of demand as it is the parameter that is consulted when choosing what to produce. At the outset, it is important to define and explain the income elasticity of demand with examples, along with its definition, its formula and the reasons for its relevance. We will then study the specific cases of the demand for potatoes and DVDs, which are two radically different types of goods. To conclude, we will analyze the demand for oil when the supply of oil is price inelastic in the short term, and then study the effects in the long term.

Extraits

[...] People mind of buying dvds when they already have all they need and that they have income left, this is a very elastic product because demand depends on people's income but also on price: as price goes up, the quantity demanded goes down, but as the income goes up the demand too and thus the price too. To confirm this let us have a look at the substitution and income effect of a price change for potatoes: assuming there are only two goods for a person to buy: dvds and potatoes, we draw the budget constraint line and the indifference curve. If there is a decrease in the price of potatoes what is happening? [...]

[...] The elasticity is positive and greater than it is a luxury good. The more the income will rise, the more will be consumed of that sort of goods We saw that a good like potatoes, a basic food is an inferior/giffen good whereas DVDs are more likely to be luxury goods with high income elasticities of demand. About the particular case of oil it is really important as it is what is happening now and how economists are trying to find solutions to that dead lock because oil resources are not infinite and furthermore are becoming more and more expensive, but are still really demanded and needed. [...]

[...] Define and explain the concept of an income elasticity of demand for a good Define and explain the concept of an income elasticity of demand for a good. Would you expect the income elasticities for potatoes and DVDs to be large or small ? If the supply of oil is price inelastic in the short term, what would you expect to be the impact of an outwards shift in the demand for oil? What might happen in the long term? [...]

[...] To solve this problem they decide to increase the production in goods that have high income elasticity of demand (and thus correspond to the new buying criteria of consumers who want more quality and more luxury) so as to in crease the sales. It is for instance the “blue parrot” patent of Sainsbury's (organic and healthy food aimed at children) or its “taste the difference” (normal goods but of much higher quality, of standard). The income elasticity also shows the level of development of a country as it shows which goods firms ought to produce if they want to make profit, which means if they want consumers to buy them. [...]

[...] We will concentrate on the income elasticity of demand as it is the one that is used to choose what to produce. First of all it is important to define and explain the income elasticity of demand with examples: its definition, its formula, why it is so important? Then we will study the cases of potatoes and DVDs, two different types of good, and work their elasticities ranges. Finally as an example we will work on the demand for oil when the supply of oil is price inelastic in the short term, in the short term and then in the long term. [...]