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
Value “own-brand” bread
+
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
Ecuador
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.
