Income elasticity of demand (YED)
Income elasticity of demand (YED) is defined as a numerical measure of the responsiveness of the quantity demanded following a change in income.
The formula for income elasticity of demand formula is as follows :
YED = %change in quantity demanded
% change in income
A positive income elasticity of demand is associated with normal goods. An increase in income will lead to a rise in demand for a normal good.
An increase in income leads to an increase in the quantity demanded for a normal good. Conversely, a decrease in income leads to a decrease in the quantity demanded for a normal good. Since there is a positive relationship, the YED has also has positive coefficient. Examples of normal goods include food staples, clothing, and household appliances.
Necessity goods are products and services that consumers will buy regardless of the changes in their income levels, therefore making these products less sensitive to income change.
A necessity good is a type of normal good. Normal necessities have an income elasticity of demand of between 0 and +1. As income rises, the demand for necessity goods rises by only a little : it is said that demand rises less than proportionately to income. Items such as staple food products such as bread and vegetables are necessity goods. This is because they have a low income elasticity of demand.
Luxury or superior goods have an income elasticity of demand greater than 1, which means they are income elastic.
This implies that consumer demand is more responsive to a change in income. The demand for luxury goods expands rapidly as people’s incomes rise. Thus items such as cars and foreign holidays have a high income elasticity of demand. Other examples of luxury goods include fine wines spirits, high quality chocolates and sports cars
Inferior goods have a negative income elasticity of demand.
An increase in income will cause a decrease in the quantity demanded for an inferior good. Conversely, a decrease in income would cause an increase in the quantity demanded for an inferior good. Here, the YED has a negative coefficient. The demand for inferior goods actually decreases as people’s incomes rise beyond a certain level. An example of an inferior good is cheap margarine. As people earn more, they switch to butter or better quality margarine.
Income Elasticity of Demand = 0
This means that the demand for the good isn’t affected by a change in income.