Income elasticity of demand

Question 1

What is income elasticity of demand?

Answer 1

Measures the relationship between the change in quantity demanded for a good and a change in real income

Question 2

What is income elasticity of demand usually abbreiviated as?

Answer 2

YED or IED

Question 3

What is the formula for YED?

Answer 3

% change in quantity demanded/% change in real income

Question 4

State the YED of a normal good

Answer 4

They will have a positive income elasticity. This means that as incomes increase, we will spend more on them

Question 5

State the YED of a normal luxury

Answer 5

They will have an income elasticity that is more than 1. This means that they will see an increase in demand that is disproportionately high compared to the change in income

Question 6

State the YED of a normal necessity

Question 7

State the YED of an inferior good

Answer 7

They will have a negative YED. This means that as incomes increase, demand for these goods will go down

Question 8

Inferior goods are counter cyclical. What does this mean?

Answer 8

Their demand rises inversely vis a vis the economic cycle. For instance, demand for inferior goods will increase during a recession

Question 9

What is an inferior good?

Answer 9

If, following a demand in real incomes, less of a good is purchased, then the good is an inferior good

Question 10

How do inferior goods operate vis a vis the economic cycle?

Answer 10

• When real incomes rise during a period of economic growth, then demand for inferior goods will fall, causing an inward shift in the demand curve
• If wages are decreasing in real terms, usually when the country is in recession, the market demand for inferior goods will increase

Question 11

Explain the downward trend in income elasticity for basic products

Answer 11

As a society becomes richer, it undergoes a change in its tastes and preferences. What might have been considered a luxury several years ago may now be regarded as a necessity

Question 12

Why might firms extend their product range?

Answer 12

To shift demand to goods with a higher income elasticity

Question 13

What can YED help businesses predict?

Answer 13

The efffect of changes in the macroeconomic cycle on their sales

Question 14

What three things does YED help businesses understand?

Answer 14

• Luxury goods with a higher YED see greater sales volativity during a business cycle than necessities, where demand is less sensitive to changes in the economic cycle
• It shows the importance of a diverse product range
• Higher value-added products increase profit margins, as they have high YED and low PED

Question 15

What does YED help businesses to plan?

Answer 15

The quantity they will sell and the price they will sell it at

Question 16

How can government policy affect average incomes?

Answer 16

• Economic growth will cause a rise in disposable income
• Increased rates of income tax will lead to a general fall in disposable income