Economics and Quantitative Analysis Income Elasticity of Demand

Question: Discuss about theEconomics and Quantitative Analysisfor Income Elasticity of Demand. Answer: Introduction According to mid- point method of calculating price elasticity, the elasticity is calculated as an average for changes in two variables. This formula uses the percentage changes calculated, which is based on the average of the initial and ending values of each variable, rather than initial values (Browning and Zupan 2014). The midpoint elasticity formula can be used to analyse the price elasticity of demand, income elasticity of demand, price elasticity of supply and cross elasticity if demand. The formula for calculating the mid-point method of price elasticity is written below : Mid-Point Elasticity = ((B2 B1)/ (B2+B1)/2 )/ ((A2-A1)/(A2+A1)/2) Where, A1 and A2 are the initial and final values f changes in price and B1 and B2 are the initial and final values of quantity demanded. There are four methods to calculate the price elasticity of demand, which could be listed as follows: Percentage Method: percentage methods calculate the percentage change in quantity demanded with respect to percentage change in price (Blau, Ferber and Winkler 2013). Point Method: according to the point or geometric method, the price elasticity is measured at a point on the demand curve. Arc Method: any two points on a demand curve make an arc. According to the arc method, the elasticity between the two points on the curve is calculated. Total Outlay Method: according to the total outlay method, price elasticity is calculated as the change in the total expenditure (Perloff 2016). The midpoint methods of calculating the price elasticity of demand is quite accurate in framing the exact approximations when the changes involved in between the initial and final quantity demanded and price of the product is quite small. Price elasticity of demand has for determinants, which can be stated as follows: Product Necessity : the greater the necessity associated with the product, the lesser is the elasticity of the product. This could be explained as, consumers tend to buy the necessity products regardless the price. Luxury goods on the other hand, tend to have a higher elasticity. Hence, it could be stated that goods that are necessary goods are inelastic in nature. Substitutes: depending upon the availability of substitutes in the market of the particular product, the elasticity of the product increases. When the product has a close substitute, it gets easier for the consumer to switch the products from one commodity to another. hence, the demand for the good becomes elastic (Eaton, Allen and Eaton 2012). Conversely, when the substitutes if the product are quite less, it does not provide an option for the consumer to change their demand for the good, hence it becomes inelastic in nature. Brand loyalty : when a consumer has an attached brand loyalty towards the product, it gets very difficult for the person to change their tastes and preferences to some other product. Hence, it can be said, that brand loyalty makes the product inelastic in nature. Price change duration: goods that are non-durable tend to be more elastic in nature in the long run, than in the short run. During short run, the span of time is quite else, hence, it gets difficult for the consumers to find substitutes for the product and thereby elasticity is comparatively low. Among the above mentioned determinants of price elasticity of demand, most important determinant is the availability of substitutes. When two goods are substitutes of each other, there is a positive relation between the price changes of one product to the quantity demanded of the other. It creates a positive elasticity between the two goods. According to the scenario of the case provided with regards to the market for cds, the price elasticity of demand could be stated as : Price elasticity = (% change in quantity demanded ) / (% change in price) In the particular case, the two goods are downloaded music and cds. Hence, it could be stated as , Price elasticity = (% change in quantity demanded of cds) / (% change in price of cds) = (30)/ ((15-21)/21) = 30/20.3 = -1.48 The value related to the elasticity, which is attained, is more than 1 and negative. The negative sign shows the negative relation that exists between the price of the good and the quantity demanded by the commodity, whereas, the value shows that the goods are relatively elastic in nature. Hence, with a slight change in price, the quantity demanded for CDs is much greater, in accordance with the law of demand. As CDS are relatively elastic in nature, it could be stated that the effectiveness if the change in price of the product is more for the consumers. Hence, it would be beneficial for the organization, universal music, to reduce the price of their products more, so that the quantity demanded increases largely. According to Rader (2014), law of demand, with the rise in price of a particular product, its quantity demanded decreases, whereas, with the fall in the price of the product, the quantity demanded increases, other thing remaining constant. This shows a negative relation between the demand and the price of a particular product. The degree of responsiveness of the change in quantity demanded due to the change in price can be measured by the price elasticity of demand. In the following case study, for the iTunes introducing 33 songs, it can be stated as the price elasticity of demand: Price Elasticity Of Demand = (% change in quantity demanded ) / (% change in price) = (-35) / ((4257-3267)/3267) = - 35 / 0.3 = -116.66 Here, the Price Elasticity of Demand is for these 33 songs is -116.66. The value related to the elasticity, which is attained, is more than 1 and negative. The negative sign shows the negative relation that exists between the price of the good and the quantity demanded by the commodity, whereas, the value shows that the goods are relatively elastic in nature. Hence, with a slight change in price, the quantity demanded for those 33 songs is much greater, in accordance with the law of demand. According to the law of demand, with the rise in price of a particular product, its quantity demanded decreases, whereas, with the fall in the price of the product, the quantity demanded increases, other thing remaining constant. This shows a negative relation between the demand and the price of a particular product. The degree of responsiveness of the change in quantity demanded due to the change in price can be measured by the price elasticity of demand (Norman et al. 2013). In the following case provided, in order to find out the price elasticity of demand, the formula could be written as: Price Elasticity Of Demand = (% change in quantity demanded ) / (% change in price) = 10/5 =2 Hence, it could be stated that chocolate is relatively elastic in nature, where the proportion of quantity demanded of chocolate sauce is greater than the proportion of price change of the product. With the change in the quantity demanded for chocolate sauce, there is a change in the quantity demanded for ice cream. To measure the relation between these two goods, cross price elasticity is conducted. cross price elasticity = (%change in quantity demanded for ice cream)/(% change in price for chocolate sauce) = (15)/(-5) = -3 Teh value for teh cross elasticity of the two goods is negative, which shows that with the fall in the price of one good, there is a rise quantity demanded of the other. Hence, there is a negative relation between the two products (Case, Fair and Oster 2014). This thereby, proves that the two goods, i.e., chocolate sauce and ice cream are substitutes to each other. Reference Blau, F.D., Ferber, M.A. and Winkler, A.E., 2013.The economics of women, men and work. Pearson Higher Ed. Browning, E.K. and Zupan, M.A., 2014.Microeconomics: Theory and Applications. Wiley Global Education. Case, K.E., Fair, R.C. and Oster, S., 2014.Principles of Microeconomics. Pearson Higher Ed. Eaton, B.C., Allen, D.W. and Eaton, D.F., 2012.Microeconomics: theory with applications. Pearson Canada. Norman, S., Schlaudraff, J., White, K. and Wills, D., 2013. Deriving the dividend discount model in the intermediate microeconomics class.The Journal of Economic Education,44(1), pp.58-63. Perloff, J.M., 2016.Microeconomics: Theory and Applications with Calculus. Pearson. Rader, T., 2014.Theory of microeconomics. Academic Press.