3.2 Income Elasticity of Demand (YED)

Question 1

What is income elasticity of demand

Answer 1

a measure of the responsiveness of demand to changes in income (curve shifts)

Question 2

formula of YED

Answer 2

% change in QD / % change in Y

Question 3

+YED means

Answer 3

positive YED means the good is normal

(positive relationship - as income increases, demand increases)

Question 4

-YED means

Answer 4

negative YED means the good is inferior

(negative relationship - as income increases, demand decreases)

Question 5

where does the curve shift due to an increase in income for a normal good

Answer 5

shifts to the right (increase in the demand for normal goods)

Question 6

where does the curve shift due to an increase in income for inferior goods

Answer 6

shifts to the left (decrease in the demand for inferior goods)

Question 7

income inelastic demand

Answer 7

YED < 1 is positive and less than one

necessities
- a percentage increase in income leads to a smaller increase in the quantity demanded

(already a necessity and demand for these goods is relatively stable)

Question 8

income elastic demand

Answer 8

YED > 1 is positive and greater than one

luxuries and services
- a percentage increase in income producers a larger percentage increase in quantity demanded

Question 9

Examples of goods with income inelastic demand

Answer 9

necessities such as food, clothing, housing

• food has income inelastic demand as the quantity demanded is fairly unresponsive to a change in income as food is a necessity
• 10% increase in income = 2% increase in quantity demanded

Question 10

Examples of goods with income elastic demand

Answer 10

luxuries such as cars, jewellery, travelling, education, restaurants

• expensive cars have income elastic demand as the quantity demanded is highly responsive to changes in income
• 10% increase in income = 15% increase in quantity demanded

Question 11

explain why a necessity and luxury depends on income levels

Answer 11

income elasticity of demand for particular items varies widely depending on income levels

COFFEE
- luxury for those in LDC’s (low income)
- necessity for those in MEDC’s (high income)

Question 12

describe how quantity demanded and income elasticity changes with an increase in income

Answer 12

as income increases: a good goes from a
luxury -> necessity -> perfectly income inelastic -> inferior

e.g. coca cola

Question 13

how does the income elasticity of demand for food vary for those with lower incomes

Answer 13

FOOD
- luxury for those with low income
- a necessity for those with high income

increase in income leads to a greater increase in quantity demanded (elastic demand) for those with lower incomes as food is considered a luxury

Question 14

which sector/goods will benefit the most from rising consumer incomes

Answer 14

goods that are luxuries (income elastic demand) as quantity demanded is responsive to changes in income

goods that are necessities (income inelastic demand) will not experience economic growth or market expansion as quantity demanded remains fairly unresponsive to changes in income

Question 15

What does YED mean for different sectors in terms of economic growth

Answer 15

ECONOMIC GROWTH
YED > 1 (elastic) = greater expansion of the market in the future, growing faster than income
YED < 1 (inelastic) = less expansion in the market

Question 16

What does YED mean for different sectors in terms of recessions

Answer 16

RECESSION
YED > 1 (elastic) = large decline in quantity demanded as income falls
YED < 1 (inelastic) = quantity demanded is relatively unresponsive as goods are necessities (can avoid large falls in sales and revenue)
YED < 0 (inferior) = increase in quantity demanded when income falls (increase in sales)

Question 17

why is YED important for firms

Answer 17

it is important for firms to know the various YED’s of goods and services in order to invest in expanding markets that will have an increase in economic growth in the long run

Question 18

What is the primary sector

Answer 18

primary commodities e.g. agriculture, fishing, extractive industries, making use of natural resources

• usually larger in developing countries

Question 19

What is the services sector

Answer 19

education, heath care, financial services, travel

• usually larger in developed countries

Question 20

What happens the primary/agricultural sector in the long run

Answer 20

primary products have a low income inelasticity and therefore the demand for output grows slower than income. Therefore, there is low economic growth and the share of agricultural output in total output in the economy shrinks, while manufactured and services grow.

• still growing but more slowly than the total output

Question 21

what happens to services and manufactured sectors in the long run

Answer 21

have high income elastic demand, therefore demand for goods and services grows faster than income.

• An increase in share for a sector means that its output is growing more rapidly than the total output