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Income elasticity of demand

Syllabus: Explain the concept of income elasticity of demand, understanding that it involves responsiveness of demand (and hence a shifting demand curve) to a change in income.

S:\TripleA\Design\icons\small\key_terms.gif Income elasticity of demand (YED)

The income elasticity of demand is a measure of the responsiveness of the quantity demanded to changes in disposable income.

Syllabus: Calculate YED using the following equation.

YED - formula

Income elasticity of demand is calculated and defined as:

Where Y = disposable income
and Qd is the quantity demanded

YED is calculated by dividing the %change in the quantity demanded for a good or service by the % change in income.

Be very clear about what the number does. Since a change in the price of other goods (Pz remember) is a non-price determinant of demand then a change in Pz will cause a shift of the demand curveīs position on a diagram. The number you calculate from the formula above shows you how far the demand curve shifts but not the direction it shifts in - the sign gives the direction.

Significance of YED sign

The sign is as important (or more important even) as the numerical value.

The demand for some products tends to increase as income increases and these are called normal goods. However there are goods that when income increases less is demanded and these are called inferior goods - think: better quality goods are sometimes preferred over poorer quality goods.

Letīs Do Some Economics

Normal and inferior goods

Syllabus: Show that normal goods have a positive value of YED and inferior goods have a negative value of YED.

Syllabus: Distinguish, with reference to YED, between necessity (income inelastic) goods and luxury (income elastic) goods.

Elasticity can be calculated and a range of values found. What do they show? What do they tell an economist?

Income elasticity may be positive or negative. If income elasticity is negative, demand decreases as income rises. Goods or services with such elasticity are called inferior goods. These might include supermarket own brands compared with specific brands or fake leather compared to real leather. Write down some other examples of inferior goods for your family.

Income increases cause the demand curve to shift to the left (negative relationship)

If the income elasticity is positive, demand increases with real income. These goods are known as normal goods. If your income increases you might choose to buy more clothes or go to the cinema more often, for example. Write down some other examples of normal goods.

The sign reveals whether the good is inferior or normal.

Some examples of calculations:

Example 1 - income elasticity of demand

Example 2 - income elasticity of demand