Income Elasticity of Demand (YED) (Edexcel A Level Business)

• Changes in income result in changes to the demand for products
  
  • • Businesses are interested in how much the quantity demanded will change for different products

• The Income elasticity of demand (YED) reveals how responsive the change in quantity demanded is to a change in income
   

Calculation

• YED can be calculated using the following formula
   

• The YED value can be positive or negative and the value is important in determining the type of good
   
• A good with a positive YED value is considered to be a normal good
  • Normal goods can be classified as necessities or luxuries
     

• A good with a negative YED value is considered to be an inferior good
  
  

Interpretation of the Numerical Values of Income Elasticity of Demand

• YED is influenced by many factors in an economy that changes the wages of workers
  • During a recession wages usually fall and demand for inferior goods rises while demand for luxury goods falls
  • During a period of economic growth and rising wages, demand for luxury goods increases while demand for inferior goods decreases
  • Other influences on income include minimum wage legislation, taxation, increased international trade
     
• YED is also influenced by the nature of the good as discussed above
  • Luxury or necessity (both are classified as normal goods)
  • Inferior or normal good

• Understanding the income elasticity of demand is useful to businesses as it can help them plan their production and products
  • Planning in this way will help them to generate higher profits and have less exposure to downturns in the economy
     
• Production planning 
  • A business needs to plan how much it is going to produce which will help it determine the number of resources such as raw materials and labour it will need
  • If a business can determine YED for its products and can accurately predict changes in income then it can plan whether to increase or decrease production 
  • It can help managers with financial planning
  • Production planning is easier when YED is relatively inelastic as demand is likely to be more constant
     
• Product planning 
  • The economy goes through different stages over time from recession to recovery and growth and so incomes will fluctuate 
  • This is known as the Business Cycle 
  • During a recession producers of inferior goods will benefit from higher demand, but will lose out when incomes rise and consumers return to normal goods
  • Some businesses might have different products in their product portfolio to take account of this
    • E.g. Tesco has its Finest, Standard, and Value range to appeal to all income segments of the market
    • E.g. During the 2008 recession, Waitrose introduced its ‘Essentials’ range of products to appeal to more budget conscious shoppers
    • E.g. VW owns Skoda, Audi, and Porsche and has different products within its ranges to appeal to different income groups