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

Definition & Calculation of YED

• 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

Interpretation of Numerical YED Values

• 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

The Factors Influencing YED

• YED is influenced by many factors in an economy that change 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 and 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

The Significance of YED to Businesses

• 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