Imagine that you get a promotion at work and your

income increases by 10%.• What will you do with the

money?• What products will you

buy more of?• Which products will

experience the greatest increase in demand?

• Will you actually buy less of some products?

Income Elasticity of Demand (YED)

Objectives

Define income elasticity of demand (YED), give the equation, explain the

possible range of values in relations to luxury goods,

normal goods, and inferior goods, and show all of the

above in diagrams

Key Concepts

YEDNormal goodInferior goodLuxury good

Definition & Equation

• Income elasticity of demand (YED) measures the responsiveness of demand to a change in income

• YED = % change in income

% change in demand

Two things you must remember…

1. The sign of the answer– If the YED is positive, an increase in income leads

to an increase in demand (and vice versa). Income and Qd move in the same direction. These are normal goods.

– If YED is negative, an increase in income leads to fall in demand (and vice versa). Income and Qd move in opposite directions. These are inferior goods

Two things you must remember…

2. The size of the answer– If the YED is greater than 1 it is a luxury good.

Here demand is very sensitive to income– If the YED is less than 1 it is a necessity. Here

demand is not particularly sensitive to income

Why it is important

• YED is important to firms because its shows what the effect of income changes might be on demand.

• If, for example, an economy is expected to grow faster in the future then the income elasticity should give an insight into what might happen to sales.

• This in turn would influence a range of areas, such as staffing levels, cashflow and profit forecasts

Different Types of Goods and their Income Elasticity

Normal Luxury Normal Necessity Inferior Good

International air travel

Fresh vegetables Frozen vegetables

Fine wines Instant coffee Cigarettes

Luxury chocolates Natural cheese Processed cheese

Private education Fruit juice Margarine

Private health care Spending on utilities Tinned meat

Antique furniture Shampoo / toothpaste / detergents

Value “own-brand” bread

Designer clothes Rail travel Bus travel

International Air travel

Income Elasticity and the Demand for Airline Travel

• Demand for airline travel has a highly 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

Complete question in chapter 9:Income Elasticity of Demand