Income Elasticity of Demand (YED)

Key Terms
Income Elasticity of Demand (YED): The responsiveness of the quantity demanded of a good to a change in income

Y: The symbol for income used by economists

∆ = Delta: The greek delta symbol is used to mean change
Theory

What is YED?


Income elasticity of demand or YED is used to measure the relationship between a change in quantity demanded for a good and a change in real income.

Equation

% ∆ in quantity demanded
% ∆ in income



Values

Positive YED = Normal Good (↑ income = ↑ demand)

  • 0 < YED < 1 = Income Inelastic = Necessary Good
  • YED > 1 = Income Elastic = Luxury Good

    • Normal goods have a positive YED, when income rises more is demanded at each price.


    Negative YED = Inferior Good (↑ income = ↓ demand)

    Inferior goods have a negative income elasticity of demand, when income rises demand falls. Examples of inferior goods include basic ranges in super markets, as people earn higher income they are likely to purchase more branded goods.


    Zero YED = Demand remains unchanged as income changes

    If a good has a YED of zero then demand will not change as income changes, these are sometimes called sticky goods.



    Why would a firm want to know YED?

    1) Sales forecasting

    A firm can forecast the impact of a change in income on sales volume and revenue.


    2) Pricing policy

    Knowing YED helps firms decided whether to raise or lower prices following a change in consumer incomes. If incomes are falling and YED is positive, a reduction in price might help compensate for the reduction in demand.


    3) Diversification

    Firms can diversify and offer a range of goods with different YEDs to spread the risk associated with changes in the level of national income. E.g. BMW produce cars with range of YED.









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