Q: Assess whether cross elasticity of demand is likely to be more important in determining the demand for electric
cars than income elasticity of demand. [12]
Answer
Cross elasticity of demand measures the responsiveness of the demand for a product to changes in
the price of a related product (substitutes or complements). Income elasticity of demand is the
responsiveness of demand to changes in consumers' income levels. Both factors are significant, but
their relative importance depends on market conditions, consumer preferences, and the economic
environment.
Electric cars (EVs) compete with traditional vehicles, making cross elasticity of demand a critical
factor. If the price of traditional vehicles rises (e.g., due to fuel taxes or regulatory costs), the demand
for EVs is likely to increase as consumers substitute towards a more cost-effective option. Similarly,
the price of electricity or charging infrastructure impacts the cost of operating an EV and,
consequently, its demand. The availability and pricing of complementary goods, such as home
chargers or renewable energy sources, also influence the appeal of electric cars.
Moreover, government policies promoting EV adoption, such as subsidies or tax incentives, effectively
lower the price of EVs relative to conventional vehicles, further enhancing the importance of cross
elasticity. As a result, the competitive dynamics between EVs and conventional vehicles, combined
with external policy interventions, make XED a significant determinant in shaping demand for electric
cars.
Income elasticity of demand is also relevant for electric cars, especially as they are generally
perceived as normal or luxury goods. Higher income levels enable consumers to afford the upfront
cost of an EV, which, despite declining over time, remains higher than that of many conventional
vehicles. As incomes rise, consumers may also prioritize environmental sustainability and innovation,
aligning with the features that EVs offer.
However, the relevance of YED is diminishing as the EV market matures. Economies of scale and
advancements in battery technology have driven prices down, making EVs accessible to a broader
range of income groups. As the cost of EVs approaches parity with conventional vehicles, income
elasticity will become less significant, particularly in developed markets where disposable income
levels are already high.
While both cross elasticity and income elasticity influence demand, XED is likely more important for
determining the demand for electric cars in the current market. This is due to the competitive and
policy-driven environment in which EVs operate. The role of substitutes and complements in shaping
consumer choices is amplified by the transition from conventional to electric vehicles. Additionally,
government interventions, such as fuel tax policies and EV subsidies, directly impact the price
dynamics and competitive landscape.
In contrast, the significance of income elasticity is more context-dependent. In developing economies
with lower average incomes, YED may play a more substantial role in determining demand. However,
in mature markets where income levels are sufficient to support EV purchases, the influence of
income elasticity diminishes compared to the competitive pricing effects captured by XED.
