Income Elasticity of Demand (YED) (Edexcel IGCSE Economics)

Defining & Calculating Income Elasticity of Demand (YED)

Spec point — 1.1.4o

• Changes in income result in changes to the demand for goods/services

  • Economists are interested in how much the quantity demanded will change for different products

• Income elasticity of demand (YED) reveals how responsive the change in quantity demanded is to a change in income

• YED can be calculated using the following formula

$\text{YED = } \frac{\% \text{change} \text{in} \text{quantity} demanded}{\% \text{change} \text{in} income} = \frac{\% \Delta \text{in} QD}{\% \Delta \text{in} \mathrm{Y} }$

Worked Example A consumer's income rises from £100 to £125 a week. They originally consumed 12 bagels at the local bakery, but this increased to 15 bagels a week. Calculate the YED of the bagels

Step 1: Calculate the % change in QD

$% \Delta \text{QD} = \frac{15 - 12}{12} \times 100

% \Delta \text{QD} = 25 %$

Step 2: Calculate the % change in Y

$% \Delta \mathrm{Y} = \frac{125 - 100}{100} \mathrm{x} 100

% \Delta \mathrm{Y} = 25 %$

Step 3: Insert the above values in the YED formula

$\text{PED} = \frac{% \Delta \text{in} QD}{% \Delta \text{in} \mathrm{Y} }

Y \text{ED} = \frac{25}{25}

Y \text{ED} = 1$

Interpreting YED Values

Spec point — 1.1.4r

• The YED value can be positive or negative and the value is important in determining the type of good

• A good with a positive YED value is considered to be a normal good

  • Normal goods can be classified as necessities or luxuries

• A good with a negative YED value is considered to be an inferior good*

Explaining YED Values

Worked Example Which one of the following best describes an income elasticity of demand (YED) of -0.7? (1)

• A. Normal necessity
• B. Inferior good
• C. Normal Luxury
• D. Elastic

Answer: B. Inferior good

Explanation

The negative YED value indicates an inferior good. A decrease in demand as consumer income rises, vice versa

The Significance of YED for Stakeholders

Spec point — 1.1.4s

• For businesses, understanding YED is important to be able to respond to changes in income

  • With an increase in income during periods of economic growth, businesses with normal goods can expect an increase in demand

    • Businesses with inferior goods can expect a fall in demand

  • With a decrease in income during periods of recession, businesses with inferior goods can expect an increase in demand

    • Business can plan to expand production if they can predict future sales based on income

  • Businesses can plan to expand or contract production or diversify goods if they can predict future sales based on income

    • By adapting production, they can maximise total revenue

• For governments, understanding YED is important, as they can create economic policies in response to changes in income

  • Governments can predict spending patterns of consumers in response to a change in income

    • They can use this to reduce inequality. By reducing taxes on lower income earners, they can increase spending on goods such as **healthcare or education **

  • Governments could increase** taxes** on goods that are not very responsive to a change in income, eg. necessity goods

    • This guarantees tax revenue, even in times of recession, where there is a fall in income