1. Income Elasticity of Demand

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3. Income Elasticity of Demand
Aims:
To understanding the concept of YeD
To have written and numerate understanding of elasticity figures (elastic & inelastic)
To understand the implications for revenue and profit (and therefore decision-making);

4. Income Elasticity of Demand
Formula
Income elasticity of demand (Yed) measures the relationship between a change in quantity demanded and a change in real income
Yed = % change in demand
% change in income

5. There are 3 different types of Income Elastic Goods

6. Income Elasticity of Demand:
Normal Good – demand rises as income rises and vice versa
Inferior Good – demand falls as income rises and vice versa

7. Income Elasticity of Demand
Look out for the sign…!
A positive sign (+) denotes a normal good
A negative sign (-) denotes an inferior good

8. The details you need to know
Income Elasticity of Demand
The details you need to know
Normal goods have a positive income elasticity of demand
As consumers’ income rises, so more is demanded at each price level
Normal goods have an income elasticity of demand of between 0 and +1
Luxuries have an income elasticity of demand > +1
So the demand rises more than proportionate to a change in income
Inferior goods have a negative income elasticity of demand.
Demand falls as income rises

9. The detailed knowledge

10. + Positive Income Elasticity
A rise in income will cause a rise in demand
A fall in income will cause a fall in demand
Coffee example…. A 10% increase in income will result in a 2.3% increase in demand for coffee.
What’s the YeD?
What will this look like on a D & S diagram?

11. Positive Income Elastic Demand Diagram
Note the axes are DIFFERENT!

12. Elastic or Inelastic + YeD
Elastic goods – are seen as LUXURIES OR SUPERIOR!
Inelastic goods – are seen as NORMAL or NECESSITIES.

13. - Negative Income Elasticity
An increase in income will result in a decrease in demand.
A decrease in income will result in a rise in demand.
ALSO known as INFERIOR GOODS

14. Negative Income Elasticity
Potatoes are seen as a inferior product
Potatoes have a YeD of -0.48
So a 10% rise in incomes will result in????
What would this look like on a D&S diagram?

15. Negative Income Elasticity Diagram = Inferior
Note the different axes labels

16. Zero Income Elasticity
This occurs when a change in income has NO effect on the demand for goods.
A rise of 5% income in a rich country will leave the Demand for toothpaste unchanged!

17. So to summarise

18. + + - Look for the signs! NORMAL GOODS LUXURY GOODS INFERIOR GOODS
BETWEEN 0 & 1
GREATER THAN 1
INFERIOR GOODS -
CAN BE A DECIMAL OR A VALUE GREATER THAN 1

19. Income Elasticity of Demand
For example:
Yed = - 0.6:
Good is an inferior good but inelastic
a rise in income of 10% would lead to demand falling by 6%
Yed = + 0.4:
Good is a normal good but inelastic
a rise in incomes of 10% would lead to demand rising by 4%
Yed = + 1.6:
Good is a normal good and elastic
a rise in incomes of 10% would lead to demand rising by 16%
Yed = - 2.1:
Good is an inferior good and elastic
a rise in incomes of 10% would lead to a fall in demand of 21%

20. So what’s a Normal, a Luxury and an Inferior good?
Income Elasticity of Demand
So what’s a Normal, a Luxury and an Inferior good?
In groups of 3’s …
You will each be ‘given’ a set of goods and you have to decide whether each is a
normal,
luxury or
an inferior good…

21. Income Elasticity of Demand
You decide….
Bus travel
Cigarettes
Designer clothes
Fine wines
Fresh vegetables
Frozen vegetables
Fruit juice
Instant coffee
International air travel
Luxury chocolates
Margarine
Stilton
Private education
Private health care
Stringy cheese
Rail travel
Shampoo
Tinned meat
Value “own-brand” bread

22. Income Elasticity of Demand
So which would have a + value BETWEEN 0 AND 1?
i.e. a NORMAL good?
So which would have a + value GREATER THAN 1?
i.e. a LUXURY good?
So which would have a negative – value? i.e. an inferior good?
Bus travel
Cigarettes
Designer clothes
Fine wines
Fresh vegetables
Frozen vegetables
Fruit juice
Instant coffee
International air travel
Luxury chocolates
Margarine
Natural cheese
Private education
Private health care
Processed cheese
Rail travel
Shampoo
Tinned meat
Value “own-brand” bread

23. A Diagram for you…

24. Relationship between Income and Quantity Demanded
Zero income
elasticity
Quantity
Negative income elasticity
[inferior good]
Positive income elasticity y1
Income y2

25. Income Elasticity of Demand for Chocolate
Which country has the sweeter tooth when it comes to income elasticity for chocolate??
Total consumption
USA 0.79
Germany 0.39
United Kingdom 0.44
France 0.60
Japan 0.08
Switzerland 1.06
Reference: Henri Jason Trends in cocoa and chocolate consumption with particular reference to developments in the major markets. Malaysian International Cocoa Conference, Kuala Lumpur, October 1994 (ICCO, ED(MEM) 686)

26. Income Elasticity and the Demand for Airline Travel
Demand for air travel has a 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

27. Your handout has different figures…annotate these to your handout
Examples of YeD
YeD mantra…
+ = normal
- = inferior!
For example:
Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 10% would lead to demand falling by 6%
Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 10% would lead to demand rising by 4%
Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 10% would lead to demand rising by 16%
Yed = - 2.1: Good is an inferior good and elastic – a rise in incomes of 10% would lead to a fall in demand of 21%
Your handout has different figures…annotate these to your handout

28. Income Per Capita and Airline Travel by Country
Why do you think New Zealand, Australia, Hong Kong and Singapore are above the trend line?

29. Airlines – a Highly Cyclical Industry
What does this mean?
Real GDP growth
% year on year
Global air traffic
% year on year

30. Significance of Income Elasticity of Demand
High Income Elasticity
Demand is sensitive to changes in real incomes
Demand is therefore cyclical – in an economic expansion, demand will grow strongly. In a recession demand may fall
Can be difficult for businesses to accurately forecast demand and make capital investment decisions

31. Significance of Income Elasticity of Demand
Low Income Elasticity
Demand is more stable during fluctuations in the economic cycle
Over time, the share of consumer spending on inferior goods and normal necessities tends to decline
Long run – businesses need to invest in / focus on products with a higher income elasticity of demand if they want to increase total profits

32. This is NOT exam practice! The exam paper will NOT look like this!
Practice time….
This is NOT exam practice!
The exam paper will NOT look like this!

33. Income elasticity of demands in a recession
Define YeD
What is the formula?
What type of YeD would you expect a luxury good should have?
Identify the different types of YeD in the table…
Product
YeD
Luxury choc
2.4
Whisky
4.1
Digestive Biscuits
0.6
Apples
0.2
Own brand baked beans
-0.4

34. Income elasticity of demands in a recession
Estimate the effect a 5% fall in income would have on each product.
Estimate the effect a 15% increase in income would have on each product.
Product
YeD
Luxury choc
2.4
Whisky
4.1
Digestive Biscuits
0.6
Apples
0.2
Own brand baked beans
-0.4

35. Homework
RED sheet
Complete Questions