## Income. Elasticity. Demand

+ Income of Elasticity Demand + Formula  Income elasticity of demand (Yed) measures the relationship between a change in quantity demanded an...
Author: Emil Horn
+

Income

of

Elasticity

Demand

+

Formula 

Income elasticity of demand (Yed) measures the relationship between a change in quantity demanded and a change in real income

 Yed

= % change in demand % change in income

+ There are 3 different types of Income Elastic Goods

+

Income Elasticity of Demand: Normal

Good – demand rises as income rises and vice versa

Inferior

Good – demand falls as income rises and vice versa

+

Look out for the sign…! A

positive sign (+) denotes a normal good

A

negative sign (-) denotes an inferior good

+

The details you need to know 

Normal goods have a positive income elasticity of demand

Luxuries have an income elasticity of demand > +1

So the demand rises more than proportionate to a change in income

Inferior goods have a negative income elasticity of demand.

Demand falls as income rises

As consumers’ income rises, so more is demanded at each price level

Normal goods have an income elasticity of demand of between 0 and +1

+

+

Positive Income Elasticity

A rise in income will cause a rise in demand

A fall in income will cause a fall in demand

Coffee example…. A 10% increase in income will result in a 2.3% increase in demand for coffee.

What’s the YeD?

+

Elastic or Inelastic + YeD  Elastic

goods – are seen as LUXURIES OR SUPERIOR!

 Inelastic

goods – are seen as NORMAL or NECESSITIES.

+

-

Negative Income Elasticity

An

increase in income will result in a decrease in demand.

A

decrease in income will result in a rise in demand.

ALSO

known as INFERIOR GOODS

+

Negative Income Elasticity 

Potatoes are seen as a inferior product

Potatoes have a YeD of -0.48

So a 10% rise in incomes will result in a fall of demand of 4.8%

+

Zero Income Elasticity 

This occurs when a change in income has NO effect on the demand for goods.

A rise of 5% income in a rich country will leave the Demand for toothpaste unchanged!

Look for the signs! NORMAL GOODS

+

BETWEEN 0 & 1 +0.5 +0.9 + 0.1

LUXURY GOODS

+

GREATER THAN 1 +2 +5 +27

INFERIOR GOODS

-

CAN BE A DECIMAL OR A VALUE GREATER THAN 1

+ 

For example: Yed = - 0.6:

Good is a normal good and elastic

Good is an inferior good but inelastic 

a rise in income of 10% would lead to demand falling by 6%

Yed = + 0.4:

a rise in incomes of 10% would lead to demand rising by 16%

Yed = - 2.1:

Good is a normal good but inelastic 

a rise in incomes of 10% would lead to demand rising by 4%

Yed = + 1.6:

Good is an inferior good and elastic 

a rise in incomes of 10% would lead to a fall in demand of 21%

+ So what’s a Normal, a Luxury and an Inferior good?

+

You decide…. 

Bus travel

Margarine

Cigarettes

Stilton

Designer clothes

Private education

Fine wines

Private health care

Fresh vegetables

Stringy cheese

Frozen vegetables

 

Rail travel

Shampoo

Fruit juice

Instant coffee

International air travel

Tinned meat

Luxury chocolates

+

A Diagram for you…

Quantity

Relationship between Income and Quantity Demanded Zero income elasticity

Negative income elasticity [inferior good]

Positive income elasticity

0

y1

Income

y2

YED for Chocolate Total consumption  USA 0.79  Germany 0.39  United Kingdom 0.44  France 0.60  Japan 0.08  Switzerland 1.06

Which country has the sweeter tooth when it comes to income elasticity for chocolate??

YED and Airline Travel 

Demand for air travel has a positive income elasticity of demand

The industry is cyclical

During an upturn, demand rises for business and leisure travel

During a recession, the demand tails away

In the long run, there is a positive relationship

between real GDP per capita and the demand for air travel 

Income elasticity will vary according to the

type of air travel 

E.g. difference between low-cost “no-frills”

and higher priced scheduled services on low-haul flights

Examples of YeD For example:

YeD mantra… + = normal - = inferior!

Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 10% would lead to demand falling by 6%

Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 10% would lead to demand rising by 4%

Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 10% would lead to demand rising by 16%

Yed = - 2.1: Good is an inferior good and elastic – a rise in incomes of 10% would lead to a fall in demand of 21%

+ Income Per Capita and Airline Travel by Country 100000

Singapore Hong Kong China

ASK (000) per capita

10000

New Zealand

100

US Switzerland

Netherlands Canada Denmark UK Norway Spain France Japan Finland Malaysia Belgium Greece Saudi Arabia Ireland SwedenGermanyAustria Thailand Portugal Korea Rep Panama Dominican Rep Italy S. Africa Lebanon Chile Costa Rica Mexico Brazil Venezuela Peru Philippines TunisiaHungary Argentina Sri Lanka Colombia Czech Rep KenyaZimbabweBulgaria Turkey Uruguay Croatia Cote D'Ivoire Slovenia SyriaLithuania Pakistan Paraguay Romania Poland Israel

1000

Australia

Why do you think New Zealand, Australia, Hong Kong and Singapore are above the trend line?

VietnamChinaAlgeria Iran Cameroon Belarus India Ukraine Nigeria Bangladesh

10 0

5000

10000

15000

20000

GNP per capita (\$ PPP)

25000

30000

35000

Airlines – a Highly Cyclical Industry Global air traffic % year on year

Real GDP growth % year on year

8 7

World real GDP growth (% vly)

16

World scheduled airline RPKs (% vly)

14 12

6 10 5

8

4

6

3

4 2

2 0 1

-2

0 1971

-4 1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

Significance of YED 

High Income Elasticity 

Demand is sensitive to changes in real incomes

Demand is therefore cyclical – in an economic expansion, demand will grow strongly. In a recession demand may fall

Can be difficult for businesses to accurately forecast demand and make capital investment decisions

Significance of YED 

Low Income Elasticity 

Demand is more stable during fluctuations in the economic cycle

Over time, the share of consumer spending on inferior goods and normal necessities tends to decline

Long run – businesses need to invest in / focus on products with a higher income elasticity of demand if they want to increase total profits

+ Practice time….

This is NOT exam practice! The exam paper will NOT look like this!

YED in a recession  Define YeD

 What

is the formula?

 What

type of YeD would you expect a luxury good should have? the different types of YeD in the table…

Product

YeD

Luxury choc

2.4

Whisky

4.1

Digestive Biscuits

0.6

Apples

0.2

Own brand baked beans

-0.4

 Identify

YED in a recession  Estimate

the effect a 5% fall in income would have on each product.

 Estimate

the effect a 15% increase in income would have on each product.

Product

YeD

Luxury choc

2.4

Whisky

4.1

Digestive Biscuits

0.6

Apples

0.2

Own brand baked beans

-0.4