Chapter 16: Problem 604

How would you define the following two elasticities: income elasticity of imports and interest elasticity of investments?

Short Answer

Expert verified

Income elasticity of imports (E_I) measures the response of a country's import demand to changes in its national income, with the formula: \(E_I = \frac{Percentage\,change\,in\,quantity\,of\,imports}{Percentage\,change\,in\,national\,income}\). Interest elasticity of investments (E_r) refers to the responsiveness of investment spending to changes in interest rates, with the formula: \(E_r = \frac{Percentage\,change\,in\,investment\,spending}{Percentage\,change\,in\,interest\,rate}\). Both concepts help understand the sensitivity of import demand and investment spending to changes in key economic factors.

Step by step solution

Definition of Income Elasticity of Imports

Income elasticity of imports measures the response of a country's import demand to changes in its income. It indicates the percentage change in imported goods and services due to a percentage change in national income.

Formula of Income Elasticity of Imports

The income elasticity of imports (E_I) can be calculated using the following formula: \[E_I = \frac{Percentage\,change\,in\,quantity\,of\,imports}{Percentage\,change\,in\,national\,income}\]

Explanation of Income Elasticity of Imports

A positive income elasticity of imports means that as the national income grows, the demand for imported goods and services increases. A negative income elasticity of imports indicates that when national income increases, the demand for imported goods and services declines. The magnitude of the income elasticity of imports determines the sensitivity of a country's import demand to income changes.

Definition of Interest Elasticity of Investments

Interest elasticity of investments refers to the responsiveness of investment spending to changes in the interest rate. It is used to understand how sensitive investment decisions are to changes in the borrowing costs.

Formula of Interest Elasticity of Investments

The interest elasticity of investments (E_r) can be calculated using the following formula: \[E_r = \frac{Percentage\,change\,in\,investment\,spending}{Percentage\,change\,in\,interest\,rate}\]

Explanation of Interest Elasticity of Investments

A positive interest elasticity of investments suggests that an increase in the interest rate will lead to an increase in investment spending, while a negative interest elasticity means that an increase in interest rate results in a decrease in investment spending. The magnitude of the interest elasticity of investments indicates how sensitive the investment behavior is to fluctuations in the interest rate. In conclusion, income elasticity of imports and interest elasticity of investments are crucial concepts in economics that help us understand the responsiveness of import demand and investment spending to changes in national income and interest rates, respectively.

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