2.2 Income Elasticity Of Demand

Question 1

Income elasticity of demand (YED)

Answer 1

It measures the responsiveness of demand for a good to changes in income of consumers , ceteris paribus

Question 2

Type of responses

Answer 2

YED<0
Inferior good
YED>1
Luxury goods
YED>0
Necessity
YED=0
Basic necessities

Question 3

Application of YED

Answer 3

1) Guide producers output decision
2) Guide non price strategy via diversification of products
- firms can diversify by offering wide range of products (including both goods normal and inferior good)
3) guide marketing strategy of products
- Firms can market their products to be more luxurious or less luxurious based on income changes

Question 4

Application Of YED FOR government

Answer 4

1. Tax policy
   - YED allows government to identity luxury and necessities
   - Through this, government will tax the luxury goods and avoid heavy tax on necessities
2. Social welfare policy
   A) targeting subsidies and support
   - Government prioritise subsidising goods with low YED

3)Economic planning
- Understanding which goods are high demand when income rise, government can invest in growing industries
- In recession, demand for luxury goods falls while necessities remain stable. Thus, government can decide which sectors to support

Question 5

Evaluation ( Essay )

Answer 5

1. Data accuracy
   - Difficulty in Estimating: Calculating YED require reliable data on income and demand changes, which may not be available
2. Assumes constant conditions
   - Ceteris Paribus Assumption
   - YED assumes all other factors remain constant, which is unrealistic
3. Limited for Long term planning ( social welfare and subsidies support)
   - However over a Long term, consumer preference nd economic condition can change ,making YED unreliable

Question 6

Conclusion (Essay)

Answer 6

While YED, can be useful , its limitation mean it should be used alongside other economic tools for policy decisions