Monday, 28 December 2009

Income Elasticity of demand

Income elasticity of demand = YED

What is income elasticity of demand?

It is the responsiveness/sensitivity of demand to income.

How do economists calculate income elasticity of demand?

Income elasticity of demand = Percentage change in quantity demanded
                                                        Percentage change in income

How do you interpret income elasticity of demand values?

If YED has a negative value (i.e. less than zero)...

The good is an inferior good. Demand decreases as income increases. It is a negative correlation. For example ASDA's Smart Price notebooks.

If YED is between 0 and 1...

The good is a necessity - it is income inelastic. Demand will increase if income increases, although demand will increase by a smaller percentage than what income will increase by. For example, If income rises by 10% then demand for lets say apples will increase by less than 10%.It has a positive correlation.

If YED is greater than 1...

This good is a luxury, a normal good. Demand will increase as income increases. The good is income elastic. However this time if income increases by 10% the demand for lets say TVs will increase by more than 10%.

Want to test yourself?

Try out this quiz - beware contains other elasticities too!


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