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## Income elasticity of demand and cross-price elasticity of demand

Current time:0:00Total duration:7:05

# Income elasticity of demand

AP.MICRO:

MKT‑3 (EU)

, MKT‑3.E (LO)

, MKT‑3.E.10 (EK)

, MKT‑3.E.9 (EK)

## Video transcript

- [Instructor] In previous videos, we have talked about the
idea of price elasticity, and it might have been
price elasticity of demand or price elasticity of supply. But in both situations,
we were talking about our percent change in quantity over our percent change in price. If we're talking about
price elasticity of demand, it would be the percent
change in quantity demanded over the percent change in price. And if we're talking about
price elasticity of supply, it would be our percent
change in quantity supplied over percent change in price. And as we talked about in many videos, this is a way of measuring how sensitive is quantity
demanded or supplied to a change in price. What we're going to see
in this video is that this is not the only type of elasticity that economists will look at. There are many types of elasticity, where they want to see "How sensitive is one thing to another?" For example, you could look at the percent change, percent change in labor supply, so you could say quantity of labor, that would be our labor supply, divided by our percent change in wages. I'll just write it out, wages. And you could view that as a percent change in the price of labor. You might say, "Hey, this
is just a price elasticity "of supply being particular
to the labor market." But you can even see things, and we'll have a whole video about this, probably my next video that I will make, where you could have
the percent change in, let's say quantity demanded of one good divided by, so let me call it good one divided by the percent change in price of not that good, then we
would have price elasticity, but of good two. And so this is actually, thinking about how good one
is a substitute for the other, and we'll go into a lot more depth there. But the focus of this video, as you can imagine because
it was already written down in a clean font right over here is Income Elasticity. And here, we're gonna think about the income elasticity of demand. And you could imagine what that would be. This is going to be our percent change in quantity demanded, demanded, divided by, instead of thinking about the percent change in price of that good or the service, we're going to think
about the percent change, change, in income of the people
who might be in the market for that good. Normally you would expect
that when our percent change in income goes up, that the same thing would
happen to our percent change in quantity demanded. For example, let's say we're talking about the market for vacations, well, as my income, as most
people's incomes go up, they might be able to afford
larger or better vacations. And that would be a normal good. This is a situation of a normal good. Normal good, just as
what you would expect. But you could actually
have the other way around. You could imagine a situation where even though you have an increase in your percent change in income, that does not lead to an
increase in your percent change in quantity demanded. In fact, it could lead to a
decrease in the percent change in quantity demanded. Or another way of thinking about it, your quantity demanded
could actually go down, so you would have a negative, a negative percent change right over here. Now could you image any
situations like that? Well, imagine if we're
talking about the market for car mechanic services. As people have more income, they might be able to afford better cars that are more reliable, that break down less, and then they would have to
go to the car mechanic less. And so that situation, where our demand would actually go down when our income goes up, or our percent change will become negative when we have a positive
percent change income, that would be, that is
known as an inferior good. Inferior good. There's two big things to take away. One, you don't just have to
think about price elasticity of supply or demand, there are other types of elasticities. But just to hit the point
home on income elasticity, let's look at a few examples. We're told: suppose that when people's income increases by 20%, they buy 10% less fast food. In this situation, what type
of good would fast food be? Pause this video and think about it. Well, their income is increasing but their demand is decreasing. That's the situation we just talked about. This is an inferior good. Inferior good. And for kicks, what is
the income elasticity of demand right over here, calculate that. Just remember, our income
elasticity of demand is just going to be our percent change in quantity demanded divided by our percent change, instead of price, we're going to say in income. I'll just write percent change of income, which is going to be what? Well, we know our
percent change in income. It went up by 20% in this example, and what happened to
our quantity demanded? Well, it went down by
10%, so negative 10%. And so here you have an
income elasticity of demand of negative one half, or negative 0.5. Let's do another example. Suppose we knew that when people's income increased
by 5% in a country, the demand for healthcare
increased by 10%. What kind of good do people consider healthcare: Normal or inferior? First, calculate the
income elasticity of demand for this example, and then
answer these questions. All right, so first we are, our income elasticity of demand. Let's see, when our
income increases by 5%, so we have a 5% increase in income, our demand for healthcare
increases by 10%. Our demand for healthcare
increases by 10%, so we get a positive income
elasticity of demand. And so in general, if
this thing is positive, you're dealing with a normal good. As income goes up, then you similarly see
quantity demanded going up. This is a normal good.