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Income elasticity of demand
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Income elasticity of demand (YED) shows how demand changes when people's incomes change.
The formula
YED = % change in quantity demanded ÷ % change in income
Example: incomes rise 5% and demand for restaurant meals rises 10%. YED = 10 ÷ 5 = 2.
Example: incomes rise 5% and demand for restaurant meals rises 10%. YED = 10 ÷ 5 = 2.
Types of good
Normal goods: YED is positive; demand rises as income rises.
Luxury goods: YED is greater than 1; demand rises by a larger percentage than income.
Inferior goods: YED is negative; demand falls as income rises (people switch to better alternatives), such as value-brand food or bus travel in some places.
Luxury goods: YED is greater than 1; demand rises by a larger percentage than income.
Inferior goods: YED is negative; demand falls as income rises (people switch to better alternatives), such as value-brand food or bus travel in some places.
Why it matters
Businesses: in a recession, sellers of luxuries suffer most, while sellers of inferior goods may gain. Firms can plan production and product ranges.
Government: YED helps predict the effects of income changes on tax revenue, and to judge how taxing or subsidising goods will affect people on different incomes.
Government: YED helps predict the effects of income changes on tax revenue, and to judge how taxing or subsidising goods will affect people on different incomes.
Incomes rise by 4% and demand for budget supermarket own-brand beans falls by 2%. Find YED and classify the good.
- YED = −2 ÷ 4 = −0.5
- Negative YED
Answer: −0.5, an inferior good
YED = %ΔQd ÷ %ΔY. Positive: normal good. Greater than 1: luxury. Negative: inferior. Businesses and governments use YED to plan for changes in income.
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