3.

3 Income Elasticity of
Demand (YED)
 Success Criteria: I can…
1. Define income elasticity of demand.
2. Measure the income elasticity of demand for a given
example.
3. Explain what a normal necessity good is and give an example.
4. Explain what a normal luxury good is and give an example.
5. Explain what an inferior good is and give an example.
 Definition of Income Elasticity of Demand
• Income elasticity of demand (YED) measures the relationship
between a change in quantity demanded and a change in real
income.
• The basic formula for calculating YED is:

%QD
%Y
• The full formula for calculating YED is:

(QD2-QD1)/QD1
(Y2-Y1)/Y1
YED = % change in quantity
demanded
% change in income

• A positive sign denotes a normal

good
• A negative sign denotes an inferior
good
 Normal Goods
• Normal goods have a positive income elasticity of demand so
as consumers’ income rises, so more is demanded at each
price level (shifts right)
(i) Necessities have a low but positive income elasticity of
demand of between 0 and +1
(ii) Luxuries have an income elasticity of demand > +1 i.e. the
demand rises (shifts right) more than proportionate to a change
in income
Example. If income rises 5% and demand shifts right by 10% then
YED = 2 and the good is a luxury
 Inferior Goods
• Inferior goods have a negative income elasticity of
demand.
• YED < 0
• Demand falls as income rises (shifts left)
 Inferior Goods
• For example:
– A 10% rise in incomes leads to a 4% decrease in the
demand for bus travel (shifts left by 4%)
– Calculate YED
– The income elasticity of demand = -4/+10
– YED = -0.4
 Success Criteria: I can…
• Examine the implications of different YED’s
in Primary, Secondary and Tertiary sectors for
both producers and the whole economy
 Significance of Income Elasticity of
Demand
• 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 Income Elasticity of
Demand
• 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
Implications of YED for Firms
 Implications of YED for Firms
What happens to demand
for primary, secondary,
Price tertiary and inferior goods
as income rises over time?

Di D0 Dp Ds&t

Quantity
 Implications of YED for Firms
Use the concept of YED and a diagram to
explain why agricultural product prices tend to
fall relative to prices of manufactured products
over the long term. (10)