Hello, everyone. This week we are going to deal with utility maximization and demand curve, in other words, “RATIONALITY”. However, in this post, we will recap on what elasticities are.
1. Elasticity of Demand
We sometimes underestimate the feature of elasticity; independent of units. The elasticity is defined at each point on a demand curve and they vary at different points in a curve. Usually, in principles of economics we have seen this;
However, this idea does not capture what elasticity of demand is. It is overly simplified. Rather, it is derivative of quantity with respect to price at each point of the demand curve. How many points do we have in a line? Infinitely a lot.
So, how do we draw a demand curve? Although we have demand curves/function given in text books, that is actually not that simply. Usually, what we know are the dots or information on elasticities of certain points. Then, we try to find the best line or curve that can connect the given dots. It is more or less a journey to find the best fitted line as we do in the econometrics. The task will get even more difficult if we want to get a smooth curve instead of a line.
2. Income Elasticity of Demand(Eta)
We have seen income elasticity identity however, there were some limitations to deal with the details.
- Eta can be both positive and negative. Suppose your income has been increased. What kind of goods will you consume more (normal/ superior goods) and less (inferior goods). Very Simple!
- Among normal goods we can once more divide into two; whether eta is larger than 1. If the percentage increase on a consumption of a good is larger than the percentage increase on income (eta>1), that is a luxury good, or vice versa.
Then, let me ask you. Is a potato inferior good? Back in the introductory courses, we learn that during the Irish great famine, potato was an inferior good. Although income was decreasing, their quantity demanded of potatoes increased. So, the conclusion here is that…
NO GOOD is INTRINSICALLY inferior. The examples in the text books are valid only under certain conditions. Let’s always be skeptical what the books are saying. Whether or not a certain good is inferior depends on the circumstances that a consumer or a market faces. For example, in the States, beer is known to be a inferior good over a wide income range. However, we can easily imagine that in some developing countries, Budweiser can be a normal good or even a luxury good.
Also, broader goods tend to be normal goods. Maybe potatoes were inferior goods during the famine, vegetables or foods in broad tend to be normal goods.
3. Engel Curves
Engel curve shows relationship between income and quantity demanded. And this is a very typical shape of it. Some features of Engel curves are the followings;
- Quantity becomes positive only when income is above certain level.
- Quantity can decrease when income becomes sufficiently high. The parts where the slope is positive, the good is regarded to be normal and where it is negative, the good is inferior. (See, nothing is intrinsically inferior)
- So, the elasticity of the Engel curve at each point is simply income elasticity of demand.
Also, let’s go back to the income elasticity identity.
From this, we can conclude that Engel curves cannot be independent of each other. We have talked about balancing the elasticities in the last posting. Should you consult that part!
So, this has been a very simple recap on elasticities, hope this have helped you on the following posts.
Thank you for your interest and see you soon!👻
