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  • Print publication year: 2005
  • Online publication date: June 2012

5 - Applications and Extensions of Demand Theory

from PART TWO - PREFERENCE, CONSUMPTION, AND DEMAND

Summary

A tax on gasoline will raise its price. By the Law of Demand, gasoline consumption will fall. But how much? And a fall in consumer incomes will likely discourage gasoline usage, but to what extent? This chapter describes the measures that economists use to quantify how consumers respond to changes in price and changes in income. Other questions addressed include: (1) Why are consumers' demands sometimes very sensitive to changes in price or in income, sometimes not? (2) What is the effect of nonprice constraints upon choice, for example rationing in wartime?

THE ENGEL CURVE AND THE INCOME ELASTICITY OF DEMAND

For any good X, the change in consumption (Δx) due to a change in income (ΔI) could be measured by the ratio ΔxI. This ratio is the slope of the Engel Curve (see Section 4.3 in the preceding chapter) over the relevant range. But there is a difficulty with the simple ratio ΔxI: it is sensitive to the units of measurement. If commodity X is butter, the numerical value of ΔxI varies depending on whether the amount of butter is stated in ounces or pounds or tons, and whether income is quoted in dollars or cents. The concept of elasticity eliminates this difficulty by expressing the variables in proportionate (percentage) terms.