3.2 Income Elasticity of Demand (YED) Flashcards
What is income elasticity of demand
a measure of the responsiveness of demand to changes in income (curve shifts)
formula of YED
% change in QD / % change in Y
+YED means
positive YED means the good is normal
(positive relationship - as income increases, demand increases)
-YED means
negative YED means the good is inferior
(negative relationship - as income increases, demand decreases)
where does the curve shift due to an increase in income for a normal good
shifts to the right (increase in the demand for normal goods)
where does the curve shift due to an increase in income for inferior goods
shifts to the left (decrease in the demand for inferior goods)
income inelastic demand
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)
income elastic demand
YED > 1 is positive and greater than one
luxuries and services
- a percentage increase in income producers a larger percentage increase in quantity demanded
Examples of goods with income inelastic demand
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
Examples of goods with income elastic demand
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
explain why a necessity and luxury depends on income levels
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)
describe how quantity demanded and income elasticity changes with an increase in income
as income increases: a good goes from a
luxury -> necessity -> perfectly income inelastic -> inferior
e.g. coca cola
how does the income elasticity of demand for food vary for those with lower incomes
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
which sector/goods will benefit the most from rising consumer incomes
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
What does YED mean for different sectors in terms of economic growth
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
What does YED mean for different sectors in terms of recessions
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)
why is YED important for firms
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
What is the primary sector
primary commodities e.g. agriculture, fishing, extractive industries, making use of natural resources
- usually larger in developing countries
What is the services sector
education, heath care, financial services, travel
- usually larger in developed countries
What happens the primary/agricultural sector in the long run
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
what happens to services and manufactured sectors in the long run
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
