Income Elasticity of Demand (IED) (YED) 1.2.5

Income Elasticity of demand - measures the relationship between A CHANGE IN QUANTITY DEMANDED FOR GOOD X and A CHANGE IN REAL INCOME.

It also shows how responsive the demand for a product is to a change in someone's  (real) income.

Formula for YED or IED:

% CHANGE IN QUANTITY DEMANDED ÷  % CHANGE IN REAL INCOME

(USE IF GIVEN PERCENTAGES LIKE A 10% INCREASE)

or

Y÷Q × Change in Quantity ÷ Change in income  (Y)

 (USE IF GIVEN ABSOLUTE NUMBERS/ WHOLE NUMBERS)

(NORMAL GOODS) (+)
▪IF INCOME GOES UP
▪DEMAND FOR THE GOOD GOES UP

(INFERIOR GOODS) (-)
▪IF INCOME GOES DOWN
▪DEMAND FOR THE GOOD GOES UP

EXAMPLE 1) Steak

If income rises from £100 to £120
And demand for steak rises from 40 to 60

The YED is as follows:

100÷40 × 20 ÷ 20 = +2.5

After getting this answer we must analyse 2 factors;

▪Sign
▪Size

The SIGN here is positive (+). This tells us that this is a NORMAL GOOD. That means our demand changes in the same direction as our income. Income has risen and so has the demand for steak.

The SIZE tells us how responsive the demand was. Here it is pretty high - 2.5. That means it's elastic as it is greater than 1. For every 1% change in my income, we get a 2.5% rise in demand for this good. This makes it INCOME ELASTIC.

Example 2) Bus Tickets

When income was £100, my quantity demanded was 200 bus tickets

However, when my income rose to £120, my quantity demanded was less at 180 bus tickets.

Same equation:

Y÷Q × Change in Quantity ÷ Change in Price  (Y)

So (£100 ÷ 200) × (-20 ÷ 20) = -0.5

Sign and Size

Sign tells us that this is an INFERIOR GOOD due to the negative (-) sign. 

Size tells us that this is an INELASTIC PRODUCT because it is less than 1 and not very responsive to a change in demand. So for every 1% increase in income, I get a 0.5% decrease in Quantity Demanded.

Knowledge of income elasticity of demand helps firms predict the effect of an economic cycle on sales. Products with high income elasticity see greater sales volatility over the business cycle than Necessities where demand from consumers is less sensitive to changes in the cycle.