Income Elasticity of Demand (YED)
This section explains the income elasticity of demand covering, calculation of income elasticity of demand, interpretation of numerical values of YED, factors influencing income elasticity of demand and the significance of YED to businesses.
Calculation of Income Elasticity of Demand
Income elasticity of demand (YED) measures the responsiveness of quantity demanded to a change in consumers' income.
Formula:
$$\text{YED} = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in income}}$$
- A positive or negative result is possible, depending on the type of good.
Interpretation of Numerical Values of YED
| YED Value | Type of Good | Interpretation |
|---|---|---|
| YED > 1 | Luxury good | Demand increases more than proportionally with income |
| YED between 0 and 1 | Normal necessity good | Demand rises with income, but less than proportionally |
| YED = 0 | Income inelastic good | No change in demand when income changes |
| YED < 0 | Inferior good | Demand falls as income rises |
- Normal goods: Have positive YED values.
- Inferior goods: Have negative YED values.
This diagram shows how income elasticity of demand (YED) affects demand curves:
Image
- D1: Original demand curve.
- Green curve (D2): Shift rightwards when income increases — typical of a normal good (YED > 0).
- Red curve (D3): Shift leftwards when income increases — indicates an inferior good (YED < 0).
Factors Influencing Income Elasticity of Demand
Nature of the good
- Necessities (e.g., bread, basic utilities) usually have low YED.
- Luxuries (e.g., designer clothes, holidays) tend to have high YED.
Level of consumer income
- In lower-income groups, even small increases in income may significantly affect demand for certain goods.
- In higher-income brackets, demand for basic necessities tends to remain stable regardless of income.
Time period
- Over time, as income expectations adjust, demand may become more or less sensitive to income changes.
Cultural and social factors
- What is seen as a necessity or luxury may vary between countries and social groups.
Significance of YED to Businesses
- Sales forecasting:
Helps predict how changes in the economic environment (e.g. recession or boom) may impact sales volumes. - Product portfolio planning:
Firms can balance products with different YEDs to reduce risk.
E.g., having both necessities (steady demand) and luxuries (higher profit margins) in a product mix. - Pricing and income segmentation:
Understanding YED supports market segmentation and pricing strategy.
Luxury brands may focus on wealthier markets or regions with rising incomes. - Strategic decision-making:
During economic growth, firms may prioritise products with high YED; in downturns, focus shifts to income-inelastic or inferior goods.
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