Income Elasticity of Demand
A measure of the responsiveness of demand for changes in income.
The formula for Income Elasticity of Demand
Similar to PED, the formula for calculating the income elasticity of demand (YED) is:
$$\mathrm{YED} = \frac{\%\Delta Q_{\mathrm{D}}}{\%\Delta Y}$$
Where:
- $\%\Delta Q_{\mathrm{D}}$ = Percentage change in quantity demanded
- $\%\Delta Y$ = Percentage change in income
Assume your income increases from $\$ 1000$ to $\$ 1250$ and your spending on clothes increases from $5$ pieces to $10$ pieces.
- First Calculate $\%\Delta Q$
$$ \%\Delta Q = \frac{10-5}{5}\times 100 = 100\%$$ - Next Calculate $\%\Delta Y$
$$ \%\Delta Y = \frac{1250-1000}{1000} \times 100 = 25\%$$ - Hence your YED for clothes at $\$ 1000$ income is:
$$ YED = \frac{\%\Delta Q}{\%\Delta Y} = \frac{100}{25} = 4 $$
Sign of YED
Unlike $PED$, income elasticity of demand will likely be positive, but there are some goods where the opposite happens.
Normal Goods (YED > 0)
Normal goods have a YED that is positive and are goods for which demand increases as consumer income rises.
Most goods are normal goods.
Inferior Goods (YED < 0)
Inferior goods have a negative YED where the demand for them decreases as consumer or household income rises.
ExampleSecond-hand clothes are likely to be inferior goods because as people's income rises, they would switch to buying new clothes.
Income Elastic vs. Income Inelastic Demand
Given that YED is positive, we can differentiate between two types.
Inelastic (0 < YED < 1)
If a good has a positive YED but less than 1, then the good has income inelastic demand.
- A percentage increase in income leads to a smaller percentage increase in demand.
- Necessity goods are income inelastic in demand.
- Even if income increases by a lot, people don't start consuming a lot of necessity goods.
Elastic (YED > 1)
If a good has a YED larger than 1, then the good has income elastic demand.
- Demand is highly responsive where there is a larger percentage increase in demand for a percentage increase in income.
