Income Elasticity Of Demand

Question 1

What is income elasticity of demand?

Answer 1

YED is the measure of responsiveness of quantity demanded of a product to a change in real income.

Question 2

How do you calculate YED?

Answer 2

YED=
Percentage change in quantity demanded
Percentage change in real income

Question 3

What does it mean if the YED result is positive?

Answer 3

The product is a normal good. I.e. a rise in real income will cause an increase in demand.

Question 4

What does it mean if the YED result is negative?

Answer 4

The product is an inferior good e.g. a rise in real income leads to a fall in demand for the product

Question 5

What values is income elasticic demand?

Answer 5

If YED is greater than +1, demand is income elastic.

Question 6

What values is income inelastic demand?

Answer 6

Whenever YED is between 0 and +1 demand is income inelastic

Question 7

Draw the diagram for normal good

Answer 7

Y axis-income
X axis-Quantity demanded
Upwards dash-normal
Upwards demand due to positive relationship between income and demand

Question 8

Draw the diagram for inferior good

Answer 8

X axis-income
Y axis-quantity demanded
Line for demand-downwards-how you would start an x-negative relationship between income and demand for inferior good

Question 9

What is the significance of YED for firms?

Answer 9

-If product is income elastic then they know that demand and total revenue will increase significantly during periods of rapid economic growth and fall significantly during recessions

-important for investment decisions

Question 10

What is the significance of YED for the government?

Answer 10

-to maximise tax revenue- during an economic boom it will place indirect taxes on those products whose demand is income elastic.

-help the government in estimating tax revenues from indirect taxes on particular goods and services.