Income Elasticity of Demand (YED)

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

Income Elasticity of Demand (YED) – Worked Example

Question

A consumer’s income rises from £2,000 per month to £2,200. As a result, the quantity demanded of a good increases from 50 units to 60 units.

Calculate the income elasticity of demand (YED).

Step 1: Calculate the percentage change in quantity demanded

(60 − 50) ÷ 50 × 100 = +20%

Step 2: Calculate the percentage change in income

(2,200 − 2,000) ÷ 2,000 × 100 = +10%

Step 3: Calculate YED

YED = 20% ÷ 10% = +2.0

Conclusion

The income elasticity of demand is +2.0. This indicates the good is income elastic, meaning demand rises more than proportionately as income increases. Such goods are often classified as luxury goods.

Test Yourself

Income Elasticity of Demand (YED) – Interactive Self-Test

Click Show answer to reveal the worked solution. Use Reset to hide everything again.

Q1) Normal good (positive YED)

Income rises from £2,000 to £2,200 per month. Quantity demanded rises from 50 to 60.
Calculate income elasticity of demand (YED).

Q2) Necessity (low positive YED)

Income increases from £30,000 to £33,000 per year. Quantity demanded for bread increases from 500 to 520 loaves per year.
Calculate YED.

Q3) Inferior good (negative YED)

Income rises from £1,500 to £1,650 per month. Quantity demanded for a budget product falls from 200 to 180.
Calculate YED.

To summarise

Definition of Inferior Good

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.

tesco-value-one — Tesco value tea bags – an inferior good

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.

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