Income Elasticity of

Demand
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Aims:
 To understanding the concept of YeD

 To have written and numerate understanding of elasticity

figures (elastic & inelastic)

 To understand the implications for revenue and profit

(and therefore decision-making);
Formula
 Income elasticity of demand (Yed) measures the
relationship between a change in quantity demanded
and a change in real income

 Yed = % change in demand

% change in income
 There are 3 different
types of Income Elastic
Goods
Income Elasticity of Demand:
 Normal Good – demand rises as income
rises and vice versa

 InferiorGood – demand falls as income

rises and vice versa
Look out for the sign…!
A positive sign (+) denotes a normal good

A negative sign (-) denotes an inferior good

The details you need to know
 Normal goods have a
positive income elasticity of
demand
 As consumers’ income rises,
so more is demanded at each
price level
 Normal goods have an
income elasticity of demand
of between 0 and +1
 Luxuries have an income
elasticity of demand > +1
 So the demand rises more
than proportionate to a
change in income
 Inferior goods have a
negative income elasticity of
demand.
 Demand falls as income rises
The detailed
knowledge
+ Positive Income Elasticity
A rise in income will cause a rise in demand

A fall in income will cause a fall in demand

 Coffee example…. A 10% increase in income

will result in a 2.3% increase in demand for
coffee.
 What’s the YeD?
 What will this look like on a D & S diagram?
Positive Income Elastic
Demand Diagram
 Note the axes are DIFFERENT!
Elastic or Inelastic + YeD
 Elastic goods – are  Inelastic goods – are
seen as LUXURIES OR seen as NORMAL or
SUPERIOR! NECESSITIES.
- Negative Income Elasticity

 Anincrease in income will result in a

decrease in demand.

A decrease in income will result in a rise in

demand.

 ALSO known as INFERIOR GOODS

Negative Income Elasticity
 Potatoes are seen as a inferior product

 Potatoes have a YeD of -0.48

 So a 10% rise in incomes will result in????

 What would this look like on a D&S diagram?

Negative Income Elasticity
Diagram = Inferior
 Note the different axes labels
Zero Income Elasticity
 This occurs when a
change in income
has NO effect on the
demand for goods.

 A rise of 5% income
in a rich country will
leave the Demand
for toothpaste
unchanged!
So to summarise
Look for the signs!
NORMAL GOODS  LUXURY GOODS

+ BETWEEN 0 & 1
+0.5 +0.9 + 0.1 + GREATER THAN 1
+2 +5 +27

INFERIOR GOODS

- CAN BE A DECIMAL OR A VALUE

GREATER THAN 1
For example:
 Yed = - 0.6:
Good is an inferior good but
inelastic
 a rise in income of 10% would
lead to demand falling by 6%
 Yed = + 0.4:
Good is a normal good but
inelastic
 a rise in incomes of 10% would
lead to demand rising by 4%
 Yed = + 1.6:
Good is a normal good and
elastic
 a rise in incomes of 10%
would lead to demand rising
by 16%
 Yed = - 2.1:
Good is an inferior good
and elastic
 a rise in incomes of 10%
would lead to a fall in
demand of 21%
So what’s a Normal, a
Luxury and an Inferior
good?

In groups of 3’s …
You will each be ‘given’ a set of goods and
you have to decide whether each is a
normal,
luxury or
an inferior good…
You decide….
 Bus travel  Margarine
 Cigarettes  Stilton
 Designer clothes  Private education
 Fine wines  Private health care
 Fresh vegetables  Stringy cheese
 Frozen vegetables
 Rail travel
 Fruit juice
 Instant coffee
 Shampoo
 International air travel
 Tinned meat
 Luxury chocolates  Value “own-brand” bread
 Sowhich
So
So whichwhich would
would
would have
have
have aa++
a negative
value
value GREATER
BETWEEN 0THAN
AND 1?
1?
– value? i.e. an inferior good?
i.e.aaNORMAL
i.e. LUXURY good?
good?
 Bus travel  Margarine
 Cigarettes  Natural cheese
 Designer clothes  Private education
 Fine wines  Private health care
 Fresh vegetables  Processed cheese
 Frozen vegetables  Rail travel
 Fruit juice  Shampoo
 Instant coffee  Tinned meat
 International air travel  Value “own-brand” bread
 Luxury chocolates
A Diagram for you…
Relationship between Income and
Quantity Demanded
Quantity

Zero
income
elastici
ty Positive income elasticity Negative income elasticity
[inferior good]

0 y1 y2
Income
Income Elasticity of Demand for
Chocolate
Which country has
the sweeter tooth
when it comes to
Total consumption
income elasticity for
 USA 0.79 chocolate??
 Germany 0.39

 United Kingdom 0.44

 France 0.60

 Japan 0.08

 Switzerland 1.06

Reference: Henri Jason Trends in cocoa and chocolate consumption with particular
reference to developments in the major markets. Malaysian International Cocoa
Conference, Kuala Lumpur, 20-21 October 1994 (ICCO, ED(MEM) 686)
Income Elasticity and the Demand
for Airline Travel
 Demand for air travel has a positive income
elasticity of demand
 The industry is cyclical
 During an upturn, demand rises for
business and leisure travel)
 During a recession, the demand tails away
 In the long run, there is a positive relationship
between real GDP per capita and the demand
for air travel
 Income elasticity will vary according to the
type of air travel
 E.g. difference between low-cost “no-frills”
and higher priced scheduled services on
low-haul flights
Examples of YeD YeD mantra…
+ = normal
- = inferior!
For example:

 Yed = - 0.6: Good is an inferior good but inelastic – a rise in

income of 10% would lead to demand falling by 6%

 Yed = + 0.4: Good is a normal good but inelastic – a rise in

incomes of 10% would lead to demand rising by 4%

 Yed = + 1.6: Good is a normal good and elastic – a rise in

incomes of 10% would lead to demand rising by 16%
Your handout has
different figures…
 Yed = - 2.1: Good is an inferior goodannotate
and elastic
these to–your
a rise in
incomes of 10% would lead to a fall in demand handout
of 21%
 Income Per Capita and Airline
100000
Travel by Country
Singapore

Hong Kong China

10000
New Zealand US
Australia Sw itzerland
Netherlands
ASK (000) per capita

Israel Canada
Denmark
Ecuador UK
Norw ay
Spain France Japan
Malaysia Finland
Saudi Arabia
Greece Ireland Belgium
Thailand Portugal Sw eden Germany
Austria
1000 Dominican Rep Panama Korea Rep
S. Africa Italy
Lebanon Chile
Costa Rica Mexico
Peru Brazil Venezuela
Philippines TunisiaHungary Argentina
Sri Lanka Colombia
KenyaZimbabw eBulgaria Turkey Czech Rep
Croatia Uruguay
Cote D'IvoireSyria Slovenia
Lithuania
PakistanParaguay Romania Poland
100 Why do you think
VietnamChinaAlgeria Iran
Cameroon Belarus New Zealand,
India Ukraine
Nigeria Australia, Hong Kong
Bangladesh and Singapore are
above the trend line?
10
0 5000 10000 15000 20000 25000 30000 35000
GNP per capita ($ PPP)
Airlines – a Highly CyclicalWhat
Industry
does this
mean?
Real GDP growth Global air traffic
% year on year % year on year

8
World real GDP growth (% vly)

7 World scheduled airline RPKs (% vly)

0
 Significance of Income
Elasticity of Demand
 High Income Elasticity
 Demand is sensitive to changes in real incomes
 Demand is therefore cyclical – in an economic
expansion, demand will grow strongly. In a recession
demand may fall
 Can be difficult for businesses to accurately forecast
demand and make capital investment decisions
 Significance of Income
Elasticity of Demand
 Low Income Elasticity
 Demand is more stable during fluctuations in the
economic cycle
 Over time, the share of consumer spending on inferior
goods and normal necessities tends to decline
 Long run – businesses need to invest in / focus on
products with a higher income elasticity of demand if
they want to increase total profits
 Practice time….
This is NOT exam practice!
The exam paper will NOT look
like this!
Income elasticity of demands
in a recession
 Define YeD Product YeD

Luxury choc 2.4

 What is the formula?
Whisky 4.1
 What type of YeD
would you expect a Digestive 0.6
luxury good should Biscuits
have? Apples 0.2

 Identify the different Own brand -0.4

types of YeD in the baked beans
table…
Income elasticity of demands
in a recession
 Estimate the effect a Product YeD
5% fall in income would
have on each product.
Luxury choc 2.4

Whisky 4.1
 Estimate the effect a
15% increase in income Digestive 0.6
Biscuits
would have on each
product. Apples 0.2

Own brand -0.4

baked beans
Homework

RED sheet

Complete Questions