1.2.5 Income Elasticity Of Demand

Question 1

What is income elasticity of demand and how is it calculated?

Answer 1

The income elasticity of demand reveals how responsive the change in quantity demanded is to a change an income
% change in quantity demanded / % change in income

Question 2

Interpretation of numerical YED values

Answer 2

• A good with a positive YED value is considered to be a normal good which can be classified as necessities or luxuries
• A good with a negative YED value is considered to be an inferior good
  >1 = luxury = demand rises when income rises and demand falls when income falls, demand is responsive to change change in (income elastic)
  0-1 =-1 necessity = demand is not very responsive to a change in income (income inelastic)
  <0 = inferior = demand rises when income falls and demand falls when income rises

Question 3

Factors influencing YED

Answer 3

The economy:
- During a recession, wage is usually full and demand for inferior goods rises while demand for luxury goods falls
- During a period of economic growth and rising wages, demand for luxury goods increases while demand for inferior goods decreases
- Also includes minimum wage legislation, taxation and increased international trade
Also influenced by the nature of the good

Question 5

The significance of YED to businesses

Answer 5

• can help them plan their production and products which will help them to generate higher profits and have less exposure to downtowns in economy

Production planning:
- Needs to plan how much it’s going to produce which will help it to determine the number of resources such as raw materials and labour it will need
- Using YED they can accurately predict changes in income which will help them plan whether to increase or decrease production
- Easier and white is relatively inelastic as demand is likely to be more constant

Product planning:
- Some businesses might have different products in their product portfolio to take into account the business cycle where the economy goes through recessions and periods of economic growth
- E.G.Tesco has its finest, standard, and value range to appeal to all income segments of the market
- e.G.vw owns Skoda, Audi, and Porsche and has different products within its ranges to appeal to different income groups