Lecture Notes: Income Elasticity of Demand

Key Concepts

Income Elasticity of Demand (YED)

• Definition: Measures the responsiveness of quantity demanded to a change in income.
• Formula:
  • YED = (% Change in Quantity Demanded) / (% Change in Income)
  • Convert changes to percentages if not already.
  • Equation: (Difference / Original) * 100 = Percentage Change.*

Types of Goods

• Normal Goods: Positive relationship between income and demand.
  • As income increases, demand increases.
  • As income decreases, demand decreases.
  • YED is positive.
• Inferior Goods: Inverse relationship between income and demand.
  • As income increases, demand decreases.
  • As income decreases, demand increases.
  • YED is negative.

Application of YED

For Normal Goods

• YED > 1: Demand is income elastic; the good is a normal luxury.
  • Demand increases more than proportionately with income increase.
• YED < 1: Demand is income inelastic; the good is a normal necessity.
  • Demand increases less than proportionately with income increase.

For Inferior Goods

• Ignore the sign for numerical interpretation.
• YED > 1: Demand is income elastic.
• YED < 1: Demand is income inelastic.
• YED = 0: Demand is perfectly income inelastic; no relationship.

Examples and Calculations

Example 1: Inferior Good

• Scenario: Income rises from £20,000 to £30,000 (50% increase).
• Good: Fast food meals decrease from 100 to 60 (40% decrease).
• YED Calculation: -0.8
  • Negative sign indicates an inferior good.
  • Absolute value < 1 indicates income inelasticity.

Example 2: Normal Good

• Scenario: Income rises from £20,000 to £25,000 (25% increase).
• Good: Furniture increases from 12 to 21 (75% increase).
• YED Calculation: +3
  • Positive sign indicates a normal good.
  • Value > 1 indicates income elasticity; normal luxury.

Diagrammatic Representation

Income on Y-axis

• Downward Sloping Demand Curve: Inferior goods.
  • Negative relationship between income and demand.
• Upward Sloping Demand Curve: Normal goods.
  • Positive relationship between income and demand.

Demand Curve Shapes

• Inelastic Demand: Steep curves.
• Elastic Demand: Shallow curves.

Conclusion

• Understanding YED helps in categorizing goods and predicting demand changes relative to income changes.
• Upcoming topics: Business relevance and limitations of elasticities.

Stay tuned for further discussions on the practical implications of elasticity in business contexts.