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QUESTION 
Elasticity of demand and supply
 
What will be the effect on price, quantity demanded and quantity supplied of luxury sports cars, given a 
significant reduction in income tax? 
ANSWER 
The demand curve for sports cars will shift to the right. Price, quantity demanded and quantity supplied 
will all go up.
The effect of a cut in income tax is to leave households with more to spend. Sports cars are a luxury 
good, so their income elasticity of demand is likely to be quite high. The percentage increase in demand 
for the cars is therefore likely to be greater than the percentage increase in after-tax household income. 
We can illustrate the change diagrammatically: 
Price
Quantity
D
0
D
1
S
P
1
P
0
Q
1
Q
0
The shift in the demand 
curve (from D
0
to D
1
) 
means that the equilibrium 
quantity demanded and 
supplied shifts from Q
0
to 
Q
1
and the equilibrium 
price increases from P
0
to 
P
1
. 
 
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PART A: THE BUSINESS ORGANISATION, ITS STAKEHOLDERS AND THE EXTERNAL ENVIRONMENT 
 
100
 
4.9 Cross elasticity of demand
Cross elasticity of demand 
is the responsiveness of quantity demanded for one good following a 
change in price of another good. 
Cross elasticity of demand = 
B
good
of 
price
the
in
change
%
*
A
good
of 
demanded
quantity 
in
change
%
*(assuming no change in the price of A) 
The cross elasticity of demand depends upon the degree to which goods are