2a.

Explain the factors which might influence the cross price elasticity of demand between different
products.
Cross price elasticity of demand (XED) measures the responsiveness of the quantity demanded in one
product to a change in price of another. For example if McDonalds changed the price of their burgers
what would be the impact on the quantity demanded for Burger King burgers. This is the formula for
how to work XED out:
XED = % change in quantity demanded for Burger King burgers / % change in price of McDonald burgers
The value of XED can be positive or negative. The factors that influence this is how closely related the
products are.
The products may be substitutes in which case the XED will be positive. As you can see in diagram 1
below when the price of good B goes up the quantity demanded for good B will also go up (assuming
ceteris paribus). This tells us that they are substitutes. Back to our example of burgers this means if
Mcdonalds burgers increased in price we would expect more people to go to Burger King and buy
burgers as these may seem better value now.

The extend to which two goods are substitutes can also impact the XED. So for example if Coke put up
their price we would expect that this would impact the quantity demanded for other brands of cola. We
might think Pepsi to be a close substitute (for most people) and therefore the XED will be >1 and this can
be seen by the diagram below. We can see that when price increases from P1 to P2 for good S that
quantity demanded for good T goes up from Q1 to Q2 a greater amount. Hence, XED will be positive
and greater than 1.

However, if the products were not as closely related the XED would be less than 1 and more inelastic.
For example, Coke may increase the price but for a supermarket cola brand the increased quantity
demanded may not be as much. This is because in the consumers eyes because of all the extra
advertising that Coke does that the supermarket cola is just not a good substitute.
The second factor is complements and how closely these products are related. For example when you
buy a games console such as a Playstation you would expect that you would buy some games to play on
it. Therefore if the price of the Playstation console increased we would expect demand for them to fall
which would lead to less Playstation games being demanded. In this case the XED would be negative as
there is a negative relationship. How high or low the XED value will depend just how close they are as
complements. So we could expect that Playstation and playstation games are quite close complements
and therefore has an XED bigger than 1.
However, if the products are weak complements the XED would be less than 1 and more inelastic. As
can be seen in the diagram below when price decrease from P1 to P2 it leads to a much smaller increase
in the quantity demanded from Q1 to Q2 and vice versa.

If the products are completed unrelated they would be have an XED of 0 which means when the price
changed for one product the quantity demanded for the other would just stay the same. Therefore the
demand curve for that product would be perfectly inelastic (vertical). An example would be in the price
changed for an Ipad that the quantity demanded for rib eye steaks will change ceteris paribus as they
are unrelated products.
Therefore the factors that impact the XED are how close substitutes or complements two products are
to each other.

2 (b) Examine the importance of income elasticity of demand for the producers of primary products,
manufactured goods and services. [15 marks]
Income elasticity of demand (YED) measures the responsiveness of demand to a change in income.
It can be worked out using the following:
YED = % change in Qd / % change in income
Knowing the elasticity is helpful for businesses operating in any sector as it will help them
understand what may happen to the demand for their product if the income of consumers change.
If they know what will happen to demand they can better plan and avoid producing too many or too
few products.
It will also allow producers to identify whether their products are inferior or normal products (and if
they are normal whether they are more a luxury or necessity).
For those producers of primary products we would expect them to be normal products as these are
commodities that come from the earth and are commodities. The YED would normally be quite
inelastic as for these products we are not necessarily going to buy lots more because we get more
income. They are used in making manufactured goods and providing services. Therefore, if we have
more income we might get less tomatoes from the shop to make are dinner as we may eat out more
but that will lead to the restaurant needing more tomatoes. As illustrated in the diagram if youre a
producer primary products and the income increases from P1 to P2 or decreases from P1 to P3 it will
lead to a much smaller change in the quantity demanded.

Overall, it is useful to a certain extent for Primary producers to know the YED but even if it was more
responsive it would be very difficult for them to plan for this as there may be no stock available to
satisfy extra demand anyway and in the short term it would be difficult to supply more. For example,
for farmers even if YED was more elastic and there was an increase in income they might want to
supply more to satisfy the demand but they will only be able to supply the number of the crop they
have, they will not be able to magic more up quickly!

For producers of manufactured goods on the other hand may have spare capacity and may be able
to change the amount they produce more quickly. Therefore they would be able to respond to a
change of income much better and avoid excess supply or demand. For services this would also be
true as they may have spare capacity and may just need to call in extra workers. However, it will
depend on the type of service and how easy it is to train/hire new workers.
The YED, as mentioned earlier and as seen in the diagram below, will show whether a product is
inferior or a normal good. As you can see below if the income increases from Y to Y1 and the
product is inferior, quantity demanded will fall from Q to Q3. Therefore there is a negative
relationship so YED will be negative. Also as you can see for a normal good when income increases
from Y to Y1 the quantity demanded will increase from Q to Q1 and for a luxury (which is a type of
normal good) it will increase by more from Q to Q2.

This is useful for producers of manufactured goods to understand as if they have inferior products
and incomes are increasing this may highlight that they need to differentiate their products more (by
advertising or product development) to make the YED more inelastic so when incomes change they
do not see a big change in the quantity demanded and therefore their revenues. It may also
highlight that they rely too much on inferior goods and they may need to add new products to their
product range that are normal goods as this will ensure whether their incomes are increasing or
decreasing that they have less risk and their revenues stay evenly distributed. For example Samsung
have a wide range of phones from really expensive to really cheap and therefore if incomes go up or
down they have phones that appeal to different people where Apple only really has the IPhone (and
now a slightly cheaper version).
Finally, as with manufactured products some may be inferior and some normal. For example a bus
for long distance trips may be an inferior service where a plane is more of a luxury. So for these the

comments for the manufactured goods on differentiation and diversification hold for services too.
However, many services may be considered more of a luxury as some many of them we can do
without or can do ourselves. Therefore if a service knows this they could use differentiation to try to
make the YED less elastic and more of a normal good and therefore become less impacted by
increase and decrease in income levels. They could also try to diversify and offer other services that
people may switch too if their incomes did fall. For example mobile phone companies offer
contracts and pay as you go. As your income increases you may have a contract (luxury) but as your
income decreases you may want to switch to pay as you go (inferior) to cut back.
Overall, YED is important for all sectors but is more useful for manufactures and service providers as
they are able to respond better and have more options when they know the YED in terms of
diversifying and differentiating products so they can limit or take advantage of changes in income
levels. Where producers of primary products due to the ability to increase, decrease or change their
supply limits what they can do with the information. Also diversifying or differentiating for the
primary producers may be much harder. For example growing apples is different from strawberries
(making it difficult to add new products and diversify) and for many consumers one apple is the
same as another (making it difficult to differentiate from other producers).