Imagine that you get a promotion at work and your income increases by 10%. What will you do with the money? What products will you buy more of? Which products will experience the greatest increase in demand? Will you actually buy less of some products?

Income Elasticity of Demand (YED) Objectives Define income elasticity of demand (YED), give the equation, explain the possible range of values in relations to luxury goods, normal goods, and inferior goods, and show all of the above in diagrams Key Concepts YED Normal good Inferior good Luxury good

Definition & Equation Income elasticity of demand (YED) measures the responsiveness of demand to a change in income YED = % change in income % change in demand

Two things you must remember… The sign of the answer If the YED is positive, an increase in income leads to an increase in demand (and vice versa). Income and Qd move in the same direction. These are normal goods. If YED is negative, an increase in income leads to fall in demand (and vice versa). Income and Qd move in opposite directions. These are inferior goods

Two things you must remember… The size of the answer If the YED is greater than 1 it is a luxury good. Here demand is very sensitive to income If the YED is less than 1 it is a necessity. Here demand is not particularly sensitive to income

Why it is important YED is important to firms because its shows what the effect of income changes might be on demand. If, for example, an economy is expected to grow faster in the future then the income elasticity should give an insight into what might happen to sales. This in turn would influence a range of areas, such as staffing levels, cashflow and profit forecasts

Different Types of Goods and their Income Elasticity Normal Luxury Normal Necessity Inferior Good International air travel Fresh vegetables Frozen vegetables Fine wines Instant coffee Cigarettes Luxury chocolates Natural cheese Processed cheese Private education Fruit juice Margarine Private health care Spending on utilities Tinned meat Antique furniture Shampoo / toothpaste / detergents Value “own-brand” bread Designer clothes Rail travel Bus travel

International Air travel

Income Elasticity and the Demand for Airline Travel Demand for airline travel has a highly positive income elasticity of demand The industry is cyclical During an upturn, demand rises for business and leisure travel During a recession, the demand tails away In the long run, there is a positive relationship between real GDP per capita and the demand for air travel Income elasticity will vary according to the type of air travel E.g. difference between low-cost “no-frills” and higher priced scheduled services on low-haul flights

Complete question in chapter 9: Income Elasticity of Demand