ECONOMICS: INCOME ELASTICITY OF DEMAND (YED)
Key Terms
Elasticity: The sensitivity of changes in a quantity with respect to changes in another quantity.
Income Elasticity of Demand (YED): An economic metric that measures the responsiveness of a quantity demanded for a good to a change in income, calculated as the percent change in demand over the percent change in income.
Superior Good: A good that makes up a larger proportion of consumption as income rises, having income elasticity greater than one.
Inferior Good: A good that decreases in demand when consumer income rises; having a negative income elasticity of demand.
What is Income Elasticity of Demand (YED)?
Income elasticity of demand is an economic metric that measures the responsiveness of a quantity demanded for a good to a change in income. This allows us to know whether a good is superior or inferior.
Superior goods are those that as income goes up so does the consumption of this good. Hence rise in income is proportional to consumption of this good. Examples of superior goods may be smoked salmon, caviar, wine, holidays…
Inferior goods are those that as income rises, consumption of them decreases. Examples of such goods are public transport, ‘store-brand’ products, instant noodles… In some scenarios we might see inferior goods being replaced with superior ones, for example replacing bus travel with cabs.
How to Work Out Income Elasticity of Demand (YED)
Income elasticity of demand can be worked out by calculating the percentage change in demand over the percentage change in income. This can be done via the following formula:
The Values of Income Elasticity of Demand (YED)
Income elasticity of demand can either be positive or negative (unliked PED which is only negative and PES which is positive). The following table represents the values and meaning of income elasticity of demand:
Why is Income Elasticity of Demand Important?
Income elasticity of demand is an important metric for producers as it lets them know what type of good (superior or inferior) their product is regarded as, this then allows them to anticipate future demand based on whether wages are increasing or decreasing.
However, it is important to note that income elasticity of demand is just an estimate and does not take into account external factors (ceteris paribus).
References/ Further Reading:
Income Elasticity of Demand (YED) – Wikipedia - https://en.wikipedia.org/wiki/Income_elasticity_of_demand