What is likely to happen to the demand for these products when incomes rise by 15%?

Theme 1: Introduction to markets and market failure In this theme, students will consider how markets work, looking at how supply and demand interact to allocate resources in local, national and international markets. They will learn how to apply supply and demand analysis to real-world situations and be able to offer explanations of consumer behaviour. This will involve looking at both how consumers act in a rational way to maximise utility and how firms maximise profit, but also why consumers may not behave rationally. 1.2 How markets work Subject content 1.2.3 Price, income and cross elasticities of demand What students need to learn: a) Understanding of price, income and cross elasticities of demand b) Use formulae to calculate price, income and cross elasticities of demand c) Interpret numerical values of: o price elasticity of demand: unitary elastic, perfectly and relatively elastic, and perfectly and relatively inelastic o income elasticity of demand: inferior, normal and luxury goods; relatively elastic and relatively inelastic o cross elasticity of demand: substitutes, complementary and unrelated goods d) The factors influencing elasticities of demand e) The significance of elasticities of demand to firms and government in terms of: o the imposition of indirect taxes and subsidies o changes in real income o changes in the prices of substitute and complementary goods f) The relationship between price elasticity of demand and total revenue (including calculation)

Income Elasticity YED measures the responsiveness of quantity demanded to a change in income it is the mathematical relationship between ∆Y & ∆Qd YED = %ΔQd % ΔY If a change in income significantly alters the Qd, then YED is said to be “relatively elastic.” If a change in income does not have much affect on Qd, then YED is said to be “relatively inelastic.”

Income Elasticity YED Tells us about the type of good: for all ‘normal’ goods, YED will be positive (as we earn more, we buy more) for ‘inferior’ goods, YED will be negative (as we earn more, we buy less) Y Normal good Inferior good Q

Income Inelastic Demand Y Income Inelastic Demand a large income change results in only a small change in Qd 0<YED <1 found on ‘necessities’ (we buy the same amount regardless of income changes) Y1 Y0 D Q0 Q1 Q

Income Elastic Demand Income Elastic Demand Y Income Elastic Demand a small income change results in a large change in Qd 1 < YED found on ‘optional’ products (a little boost in income suddenly adds these items to our basket) D Y1 Y0 Q0 Q1 Q