1.7 Income elasticity of Demand (YED)

YED - what is it?

YED measures how much quantity demanded changes when consumer income changes

What is a positive YED value mean?

A positive YED value means the good is a normal good.

• when demand increases so does income increases

What is a negative YED value mean ?

A negative YED value means the good is an inferior good - demand decreases when income increases (bus rides, instant noodles)

How does YED help businesses and governments ?

1. helps predict demand based on income trends

2. firms can target luxury vs necessity markets

3. Governments can understand how economic growth affects different industries

What happens to demand for different types of goods as income rises

• demand for normal goods - demand increases with income YED > 0

• Demand for inferior goods - demand decreases as income rises YED < 0

• Demand for luxury goods - demand grows more than proportionally income YED > 1

What is the significance of YED for economic development ?

1. Predicts demand patterns as income grows

   → in Developing countries incomes are rising

2. As countries become richer

demand shifts too manufactured and service goods helping economies grow and diversify

3. Helps businesses plan

4. Helps gov with policy planning (investment and infrastructure, trade policies accordingly knowing which industries will rise when income does)

Engel’s law

explain why services (travel, entertainment, education) dominate in high-income economies

How do the three sectors behave as the economy develops?

1. Primary sector demand

• grows the slowest (may even fall)

2. Secondary sector demand

• grows at a moderate rate

3. Tertiary sector (produces services) demand

• grows the fastest