1.2.3 - Income Elasticity of Demand

Question 1

Define Income Elasticity of Demand (YED)

Answer 1

. Measures the responsiveness of Demand to a change in one’s income

Question 2

Equation for Income Elasticity of Demand (YED)

Answer 2

% Change in Q.D / % change in Income

Question 3

Name two types of goods

Answer 3

. Normal Goods

. Inferior Goods

.

Question 4

Define Normal Goods

Answer 4

. A good where demand increases when income increases

. It has a positive income elasticity + (YED).

Question 5

Define Inferior Goods

Answer 5

. A good where demand decreases when income increases

. It has a negative income elasticity - (YED).

Question 6

When is Income Elasticity of Demand (YED) for Normal Goods Elastic?

Answer 6

. When YED > 1 for normal goods demand is income elastic

. It means that if incomes goes up, demand for this normal good goes up proportionately greater than the increase in income

. This good is a normal luxury. This is as we weren’t buying as much of it before due to the cost.

Question 7

When is Income Elasticity of Demand (YED) for Normal Goods Inelastic?

Answer 7

. When YED < 1 for normal goods demand is income inelastic

. When incomes rises, the demand for this good rises but proportionately less than the increase in income

. This good is a normal necessity. This means we were already buying this good showing that it is a necessity

Question 8

When is Income Elasticity of Demand (YED) Elastic for Inferior Goods?

Answer 8

. YED is Elastic for Inferior goods when YED > 1

. As income rises, the demand for this good rises proportionately more than the rise in income

Question 9

When is Income Elasticity of Demand (YED) Inelastic for Inferior Goods?

Answer 9

. YED is Inelastic for Inferior goods when YED < 1

. As income is rising, quantity demanded for inferior goods is decreasing, but proportionately less than than the increase in income.

Question 10

What happens if YED = 0

Answer 10

Then demand is perfectly income inelastic

For both inferior and normal goods

Question 11

Examples of Inferior Goods

Answer 11

. These tend to low quality goods:

. Bus transport
. Margarine
. Spam
. Fast Food

Question 12

Explain the Business Significance of YED

Answer 12

. YED provides businesses crucial information regarding the relationship of demand for goods and income

. This information from YED is highly significant in preparation for expected BOOMS or RECESSIONS in the economy

Question 13

Example of Business Significance of YED for Normal Goods

Answer 13

. If a business calculates YED for a product to be +4 it means that it is a normal good with income elastic demand. It is a luxury good

. This means that if a boom is forecast with incomes rising by 5%, there would be a 20% increase in quantity demanded for this product. (5*4 is 20. This can be solved using YED equation)

. In this case a business must prepare by increasing its levels of stock output and employment to meet this higher demand. They can also increase human capital value to increase production by increasing training and education

. A business may also look to increase prices during a boom, as demand will have increased for goods and their is opportunity for an increase in total revenue.

Question 14

Explain Business Significance level of YED for Inferior Goods

Answer 14

. If a business calculates YED to be -4, it means the good is an inferior good with income elastic demand

. If a RECESSION is forecast, with income expected to decrease by 5%, there would be a 20% decrease in quantity demanded for this good (can be solved by YED equation)

. Therefore, the business should decrease its levels of stocks, output and employment due to lower demand. They could look at other ways of stimulating demand such as advertising to reduce the impact of lower demand and lower revenue during the boom

. A business may also look to decrease their price in a boom, to stimulate demand

Question 15

Define Luxury Good

Answer 15

. Type of normal good, when YED > 1