1.2.5 Income Elasticity of Demand (YED)

Inferior goods

As incomes of consumers rise, demand falls for inferior goods because people choose to spend on the better quality goods e.g a bus

Normal goods

As incomes of consumers rise, demand rises for normal goods. For 'necessities' like groceries the rise in demand is relatively small. For 'luxuries' demand tends to rise more significantly as they become more affordable. E.g a necessity like fruit and veg and a luxury is

Income Elasticity of Demand Equation (YED)

%change = new - original/ original x100

% change in Demand/ % change in Income x 100

Y = income

Negative YED value

= an inferior good

Positive (0 - 1) YED value

= a normal necessity

Positive (> 1) YED value

= a normal luxury

YED compared to PED

Unlike PED (which is always negative), YED doesn't follow the same pattern...

With YED, the figure can be either positive or negative

This relates to what type of good it is:

1) Normal good (+) when incomes rise, demand rises too

2) Inferior good (-) 🡪 when incomes rise, demand falls

Elasticty

Elasticity measures the responsiveness of demand to change in a relevant variable - such as price or income

Factors that influence YED values

1) How attractive is the product to consumers?

-Some products remain in high demand even if consumers' incomes are not growing, e.g. the latest iPhone

-This is due to factors such as brand loyalty, the need for consumers to treat themselves etc.

2) What proportion of a consumer's income is spent on the product?

-A new car takes up a large chunk of most consumers' income & therefore demand is sensitive to changes in incomes, i.e. it is a normal 'luxury'

-Whereas a Netflix subscription is relatively cheap, so demand is less sensitive to changes in incomes

The significance of YED for business

-YED helps businesses understand how consumer demand is likely to respond to rising or falling incomes

-So if the economy is growing and incomes rising, there is likely to be more demand for normal goods, especially luxuries such as new cars, foreign holidays etc.

-The reverse is true during a recession - consumers are likely to cut back on luxuries and/or switch to inferior substitutes, e.g. second-hand cars, staycations etc.

-Therefore, businesses need to plan for economic ups and downs to meet the changing patterns in demand

Income Elasticity of Demand

Measures to the extent to which the quantity of a product demanded is affected by a change in income

Inferior vs Normal goods

-Inferior - as incomes rise consumption falls, e.g. pot noodles

-Normal - as incomes rise consumption rises:

-Normal 'necessity' - not affected so much by income, e.g. your consumption of water will not rise if you earn more money - but you may buy a more expensive brand of bottled water

-Normal 'luxury' - the rise in demand is proportionally larger than the rise in income, e.g. caviar

Interpreting Income Elasticity of Demand Data

-Doing this will help a firm understand how a price change will impact their sales.

-If the income elasticity of demand is less than 1 then this is described as inelastic. This means that a change in income will lead to a change in quantity demanded which is less than the change in income.

-If the income elasticity of demand is greater than 1 then this is described as elastic. This means that a change in income will lead to a change in quantity demanded which is greater than the change in income.

Income elasticity of demand

-Income elasticity of demand (YED) measures the responsiveness of quantity demanded to a change in consumer income.

-Businesses can use income elasticity of demand to understand how the quantity demanded by customers will change in response to income.

YED coefficients

-The larger the income elasticity of demand coefficient (number) the greater the responsiveness of quantity demanded to a change in income.

-If the coefficient is positive, an increase in income will increase demand and a fall in income will decrease demand.

-If the coefficient is negative, an increase in income will decrease demand and a fall in income will increase demand.

Change in YED

For example, the income elasticity demand for premium cars is relatively elastic as consumers may decide they cannot purchase a new vehicle if their income reduced, so quantity demanded is likely to change by more than the change in income.

How could an elasticity that's elastic effect demand?

-Any change in income will result in a greater change in quantity demanded

What does a minus show

-The minus shows that an increase in one variable will decrease the other variable.