Income elasticity of demand measures the responsiveness of demand for a good to changes in consumer income. There are three types: 1) Normal goods have a positive income elasticity - demand increases as income rises. Luxury goods have an elasticity greater than 1. 2) Inferior goods have a negative elasticity - demand decreases as income rises. 3) Some goods like necessities have an inelastic positive elasticity between 0 and 1. The document provides examples and formulas for calculating income elasticity. It explains how businesses can use elasticity figures to forecast demand and make investment decisions depending on whether demand is more sensitive or stable to economic cycles.

1. Income Elasticity of
Demand
Prepared By: Milan Padariya

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3. 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);

4. 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

5. There are 3 different
types of Income Elastic
Goods

6. Income Elasticity of Demand:
 Normal
Good – demand rises as income
rises and vice versa
 Inferior
Good – demand falls as income
rises and vice versa

7. Look out for the sign…!
A
positive sign (+) denotes a normal good
A
negative sign (-) denotes an inferior good

8. The details you need to know

Normal goods have a
positive income elasticity of
demand
So the demand rises more
than proportionate to a
change in income


Luxuries have an income
elasticity of demand > +1



Inferior goods have a
negative income elasticity
of demand.

Demand falls as income
rises
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

9. The detailed
knowledge

10. +
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?

11. Positive Income Elastic
Demand Diagram
 Note
the axes are DIFFERENT!

12. Elastic or Inelastic + YeD

Elastic goods – are
seen as LUXURIES
OR SUPERIOR!

Inelastic goods – are
seen as NORMAL or
NECESSITIES.

13. -
Negative Income Elasticity
 An
increase 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

14. 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?

15. Negative Income Elasticity
Diagram = Inferior
 Note
the different axes labels

16. 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!

17. So to summarise

18. Look for the signs!
NORMAL
+
GOODS

+
BETWEEN 0 & 1
+0.5 +0.9 + 0.1
INFERIOR
-
LUXURY
GOODS
GREATER THAN 1
+2 +5 +27
GOODS
CAN BE A DECIMAL OR A VALUE
GREATER THAN 1

19. 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%

20. 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…

21. You decide….










Bus travel
Cigarettes
Designer clothes
Fine wines
Fresh vegetables
Frozen vegetables
Fruit juice
Instant coffee
International air travel
Luxury chocolates









Margarine
Stilton
Private education
Private health care
Stringy cheese
Rail travel
Shampoo
Tinned meat
Value “own-brand” bread

22. So which would have
value
So which would have a negative
So which would have a a++value
GREATER THAN good?
BETWEEN inferior 1?
0 AND 1?
– value? i.e. an
i.e. NORMAL good?
i.e. a a LUXURY good?










Bus travel
Cigarettes
Designer clothes
Fine wines
Fresh vegetables
Frozen vegetables
Fruit juice
Instant coffee
International air travel
Luxury chocolates









Margarine
Natural cheese
Private education
Private health care
Processed cheese
Rail travel
Shampoo
Tinned meat
Value “own-brand” bread

23. A Diagram for you…

24. Quantity
Relationship between Income
and Quantity Demanded
Zero
income
elastici
ty
0
Negative income elasticity
[inferior good]
Positive income elasticity
y1
Income
y2

25. Income Elasticity of Demand for
Chocolate
Total consumption
 USA 0.79
 Germany 0.39
 United Kingdom 0.44
 France 0.60
 Japan 0.08
 Switzerland 1.06
Which country has
the sweeter tooth
when it comes to
income elasticity for
chocolate??
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)

26. 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

27. Examples of YeD
For example:
YeD mantra…
+ = normal
- = inferior!

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…
annotate these to your
good andhandout – a
elastic
Yed = - 2.1: Good is an inferior
rise
in incomes of 10% would lead to a fall in demand of 21%

28. Income Per Capita and Airline
Travel by Country
100000
Singapore
Hong Kong China
ASK (000) per capita
10000
New Zealand
Australia
Sw itzerland
US
Netherlands
Canada
Denmark
UK
Norw ay
Spain
France
Japan
Malaysia
Finland
Belgium
Saudi Arabia
Greece
Ireland eden
Germany
Sw
Portugal
Austria
Thailand
Panama
Korea Rep
Dominican Rep
1000
Italy
S. Africa
Lebanon
Chile
Costa Rica
Mexico
Brazil Venezuela
Peru
Philippines
TunisiaHungary Argentina
Sri Lanka
Colombia
Why do you think
Czech Rep
Zimbabw e
Kenya
Bulgaria Turkey
Uruguay
New Zealand,
Cote D'IvoireSyria Croatia
Slovenia
Lithuania
Australia, Hong Kong
Pakistan
Paraguay Romania Poland
Israel
Ecuador
100
and Singapore are
above the trend line?
VietnamChinaAlgeria Iran
Cameroon Belarus
India Ukraine
Nigeria
Bangladesh
10
0
5000
10000
15000
20000
GNP per capita ($ PPP)
25000
30000
35000

29. Airlines – a Highly Cyclical
What does this
Industry
mean?
Global air traffic
% year on year
Real GDP growth
% year on year
8
16
World real GDP growth (% vly)
World scheduled airline RPKs (% vly)
7
14
12
6
10
5
8
4
6
4
3
2
2
0
1
-2
0
1971
-4
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001

30. 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

31. 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

32. Practice time….
This is NOT exam practice!
The exam paper will NOT look
like this!

33. Income elasticity of demands
in a recession

Define YeD
Product

What is the formula?
Luxury choc
2.4
Whisky
4.1
Digestive
Biscuits
0.6
Apples
0.2
Own brand
baked beans
-0.4


What type of YeD
would you expect a
luxury good should
have?
Identify the different
types of YeD in the
table…
YeD

34. Income elasticity of demands
in a recession


Estimate the effect a
5% fall in income would
have on each product.
Estimate the effect a
15% increase in
income would have on
each product.
Product
YeD
Luxury choc
2.4
Whisky
4.1
Digestive
Biscuits
0.6
Apples
0.2
Own brand
baked beans
-0.4