Income Elasticity of Demand (YED)

Question 1

Income elasticity of demand

Answer 1

The responsiveness of quantity demanded to a change in income

Question 2

Elastic YED

Answer 2

When quantity demanded changes more than proportionally to a change income
- luxury good
- YED > 1

Question 3

Inelastic YED

Answer 3

When quantity demanded changes less than proportionally to a change income
- necessity
- 0 < YED <1

Question 4

Positive YED

Answer 4

• demand for good goes up when income goes up
• demand for good goes down when income goes down
• normal good
• YED > 0

Question 5

Negative YED

Answer 5

• demand for good goes up when income goes down
• demand for good goes down when income goes up
• inferior good
• YED < 0

Question 6

Determinants of YED

Answer 6

1. Nature of good
- if necessity or luxury good
- depends upon whether developing or developed

2. Time period
- overtime goods become more inelastic (become more of a necessity)
- due to changes in consumer demand and preferences
- depends whether developing or developed
- time lag and consumer inertia

3. Income is not the only factor
- depends on quality of the good
- price of substitutes

4. Depends if income is permanent or temporary
- if permanent income spend more on luxuries as they know their income will always go up
- if people have termporary income they may save instead as dont know whether they will continue earning it

5. The proportionate change in spending
- spending comes from an increase in income
- a small change mean not have that much change in demand
- depends upon relative disposable income to inflation

Question 7

The impact of an increase in income on a luxury good

Answer 7

• if rdy increases people buy more luxury goods
• demand increases more than proportionately to a change income
• demand shifts to the right and extension on the supply curve as prices increase

Question 8

The impact of an decrease in income on a luxury good

Answer 8

• if rdy increases people buy less luxury goods
• demand decreases more than proportionately to a change income
• demand shifts to the left and contraction on the supply curve as prices increase

Question 9

The impact of an increase in income on a necessity

Answer 9

• If rdy increases people won’t buy as much necessities as can already afford them
• quantity demanded goes up less than proportionately to a change income
• demand only shifts a little bit to the right

Question 10

The impact of an decrease in income on necessity

Answer 10

• If rdy decreases people buy necessities
• quantity demanded goes down less than proportionately to a change income
• demand only shifts a little bit to the left

Question 11

YED is useful

Answer 11

1. Diversification
- a firm should sell inferior normal and luxury goods
- firms should have a large portfolio
- beneficial as in varying economic climates demand for some products will always go up so you can always maximize profits

2. Whether or not to increase price elasticity of supply
- if you’re selling a luxury good during an economic boom you should invest in factors of production
- by knowing the YED and economicd climate firms are able to know whether or not to increase capacity to easily meet demand

3. Whether to enter or leave the industry
- When the economy is going through a boom a lot of firms join the luxury market as demand increases more than proportionately so maximum profit
- Firms should exit the luxury market during a recession and enter the inferior good market as demand increases

Question 12

Why is YED not useful?

Answer 12

1. YED is only an estimate
- samples are prone to error so the estimate could be wrong
- firms may increase prices when they should actually bE lower
- may informs wrongly
- if think a normal good is a luxury good and think demands increases much more during a boom firms may invest in factors of production but it does not actually have high demand and so waste fop

2. Maybe outdated
- become obsolete due to changes in trends
- nature of good changes over time and be more inelastic

3. Ceteris parabus may not hold
- There are other things that can impact demand
- price of substitutes and complements
- even if calculate the good to be income elastic the government may put quotas in place to prevent you from selling as much

4. YED relies on being able to accurately predict changes in income
- cannot predict income as not all sources of income are declared such as the informal sector
- volatility in the macroeconomiccycle so cannot predict