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Income Elasticity of Demand (YED) (Edexcel IGCSE Economics)

Revision Note

Lorraine

Written by: Lorraine

Reviewed by: Steve Vorster

Defining & Calculating Income Elasticity of Demand (YED)

  • Changes in income result in changes to the demand for goods/services

    • Economists are interested in how much the quantity demanded will change for different products

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

  • YED can be calculated using the following formula

text YED =  end text fraction numerator percent sign space change space in space quantity space demanded over denominator percent sign space change space in space income end fraction space equals space fraction numerator percent sign triangle space in thin space QD over denominator percent sign triangle in space straight Y end fraction

Worked Example

A consumer's income rises from £100 to £125 a week. They originally consumed 12 bagels at the local bakery, but this increased to 15 bagels a week. Calculate the YED of the bagels

Step 1:  Calculate the % change in QD

  percent sign triangle QD space equals space fraction numerator 15 minus 12 over denominator 12 end fraction space cross times 100 percent sign triangle QD space equals space 25 percent sign 


Step 2: Calculate the % change in Y

percent sign triangle straight Y space equals space fraction numerator 125 space minus space 100 over denominator 100 end fraction space straight x space 100 percent sign triangle straight Y space equals space 25 percent sign


Step 3: Insert the above values in the YED formula

PED space equals space fraction numerator percent sign triangle space in thin space QD over denominator percent sign triangle in space straight Y end fraction Y ED space equals space 25 over 25 Y ED space equals space space 1

Interpreting 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

Explaining YED Values

Value

Type of Good

Explanation

0 → 1

Normal necessity

  • Demand increases when income increases

  • Income inelastic, which means that it is relatively unresponsive to a change in income 

YED > 1

Normal luxury

  • Demand increases when income increases

  • Income elastic, which means that it is relatively responsive to a change in income 

YED < 0

Inferior good

  • Demand decreases when income increases

Worked Example

Which one of the following best describes an income elasticity of demand (YED) of -0.7? (1)

  • A. Normal necessity

  • B. Inferior good

  • C. Normal Luxury

  • D. Elastic

Answer: B. Inferior good

Explanation

The negative YED value indicates an inferior good. A decrease in demand as consumer income rises, vice versa

The Significance of YED for Stakeholders

  • For businesses, understanding YED is important to be able to respond to changes in income

    • With an increase in income during periods of economic growth, businesses with normal goods can expect an increase in demand

      • Businesses with inferior goods can expect a fall in demand

    • With a decrease in income during periods of recession, businesses with inferior goods can expect an increase in demand

      • Business can plan to expand production if they can predict future sales based on income

    • Businesses can plan to expand or contract production or diversify goods if they can predict future sales based on income

      • By adapting production, they can maximise total revenue

  • For governments, understanding YED is important, as they can create economic policies in response to changes in income

    • Governments can predict spending patterns of consumers in response to a change in income

      • They can use this to reduce inequality. By reducing taxes on lower income earners, they can increase spending on goods such as healthcare or education

    • Governments could increase taxes on goods that are not very responsive to a change in income, eg. necessity goods

      • This guarantees tax revenue, even in times of recession, where there is a fall in income

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    Lorraine

    Author: Lorraine

    Expertise: Economics Content Creator

    Lorraine brings over 12 years of dedicated teaching experience to the realm of Leaving Cert and IBDP Economics. Having served as the Head of Department in both Dublin and Milan, Lorraine has demonstrated exceptional leadership skills and a commitment to academic excellence. Lorraine has extended her expertise to private tuition, positively impacting students across Ireland. Lorraine stands out for her innovative teaching methods, often incorporating graphic organisers and technology to create dynamic and engaging classroom environments.

    Steve Vorster

    Author: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.