Income elasticity of demand (YED) measures the responsiveness of demand to a change in income.
For example, if your income increase by 5% and your demand for mobile phones increased 20% then the YED of mobile phones = 20/5 = 4.0
This occurs when an increase in income leads to a fall in demand. Therefore YED<0. When your income increase you buy better quality goods and so buy less of the low-quality goods.
Examples of inferior goods clothes from charity shops, cheap bread.
For example, if your income increased 10% and demand for Tesco Value tea fell 15%. The YED = -15/10 = -1.5
Definition of Normal good
This occurs when an increase in income leads to an increase in demand for the good, Therefore YED >0
For example, if demand for apples rose 4% after a 10% rise in income. The YED = 4/10 = 0.4
Definition of Luxury good
This occurs when an increase in demand causes a bigger percentage increase in demand, therefore YED>1.
For example, if your spending on Game Apps increases 25% after a 10% increase in income – this is luxury good; the YED = 2.5
- Luxury goods will also be normal goods and we can say they will be income elastic.
- Income inelastic. This means an increase in income leads to a smaller % increase
in demand. Therefore 0> YED <1
Using knowledge of income elasticity of demand
- Firms will make use of income elasticity of demand by producing more luxury goods during periods of economic growth.
- In a recession with falling incomes, supermarkets might be advised to promote more ‘value’ inferior goods.