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Additional Topics in Demand Theory
KEY TERMS AND CONCEPTS Advertising elasticity of demand A measure of the sensitivity of consumer demand for a good or a service in response to a change in the advertising expenditures of a firm or an industry. The advertising elasticity of demand is computed as the percentage change in the demand for a good or a service divided by the percentage change in advertising expenditures. In practice, advertising expenditures are often used as a proxy for tastes and preferences in the demand function. Arc-price elasticity of demand The price elasticity of demand that is calculated over a price–quantity interval by using the simple average as the base. A knowledge of only two price–quantity combinations is required to calculate an arc-price elasticity of demand. Complement In the case of a complement, the change in the demand for a good or service is inversely related to a change in the price of a related good or service, and the cross-price elasticity of demand is negative. Cross-price elasticity of demand A measure of the sensitivity of consumer demand for a good or a service in response to a change in the price of a related good or service. The cross-price elasticity of demand is computed as the percentage change in the demand for a good or a service divided by the percentage change in the price of a related good or service. Elastic demand Demand is elastic when the percentage increase (decrease) in the quantity demanded of a good or a service is greater than the percentage decrease (increase) in its price. When the demand for a good or a service is price elastic, an increase (decrease) in the price of that good or service will result in a decrease (increase) in the total revenue earned by the firm or industry selling that good or service. Elasticity Whenever there is a functional relationship between a dependent variable and an independent (explanatory) variable, it is theoretically possible to calculate a measure of elasticity. Elasticity is a measure of the sensitivity of a dependent variable to changes in an independent (explanatory) variable. Elasticities are computed as the percentage change in the value of the dependent variable divided by the percentage change in the value of the independent (explanatory) variable. Income elasticity of demand A measure of the sensitivity of consumer demand for a good or a service in response to a change in income. The income elasticity of demand is computed as the percentage change in the demand for a good or a service divided by the percentage change in income. Inelastic demand Demand is inelastic when the percentage increase (decrease) in the price of a good or a service is less than the percentage decrease (increase) in its price. When the demand for a good or a service is price inelastic, an increase (decrease) in the price of that good or a
