1.2.5 Income Elasticity of Demand

Question 1

What is income elasticity of demand (YED)?

Answer 1

• YED measures the responsiveness of quantity demanded given a change in incomes.

Question 2

What is the formula to calculate YED?

Answer 2

%Change in Quantity Demanded/
%Change in income

Question 3

When is the demand inelastic?

Answer 3

• If YED is between 0 and 1

Question 4

When is the demand elastic?

Answer 4

• If YED is more than 1

Question 5

What type of YED does a normal good have?

Answer 5

• A good with a positive YED

(is considered to be a normal good- these can be both luxury or necessity)
* If a figure has a + it is a normal good

Question 6

What type of YED does an inferior good have?

Answer 6

• A good with a negative YED

(is considered to be an inferior good- As income rises demand falls/as income fall demand increases)
* If a figure has a - it is an inferior good

e.g. microwave meals,unbranded goods

Question 7

What factors influence income elasticity of demand?

Answer 7

The nature of goods:
Necessitites- demand for these will become inelastic
Luxury’s demand for these goods will become elastic

Economic factors:
* During recession-wages fall & demand for inferior goods rises while demand for luxury goods falls
* A period of economic growth & rising wages- demand for luxury goods increases while demand for inferior goods falls
* Other influences on income- minimum wage legislation, taxation, increased international trade

Question 8

How is understanding income elasticity of demand useful to a business?

Answer 8

• It can help them plan their production & products

Planning in this way will help them to generate higher profits & have less exposure to downturns in the economy

Question 9

How will a business plan their production depending on YED?

Answer 9

• Business needs to plan how much it’s going to produce-which will help determine the number of resources such as raw materials & labour it will need
• If business can determine YED for its products & can accurately predict changes in income then it can plan whether to increase or decrease production
• Production planning is easier when YED is relatively inelastic as demand is likely to be more constant

Question 10

How will a business plan their product depending on YED?

Answer 10

• During recession producers of inferior goods will benefit from higher demand, but will lose out when incomes rise & consumers return to normal goods
• Some businesses might have different products in their product portfolio (diff products & services) to take account of this