Elasticity » Income Elasticity of Demand
What you'll learn this session
Study time: 30 minutes
Edexcel spec: 1.1.4 (o)-(r)
- What income elasticity of demand (YED) means and how to calculate it
- How to read the number: luxury, normal and inferior goods
- Why the plus or minus sign matters so much
- How to answer a YED question on Paper 1
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Unlock This CourseHow does demand react when people get richer?
As incomes rise, spending on luxuries like overseas holidays rises even faster: YED above 1
Imagine your family gets a pay rise. Some things you buy will go up: perhaps more meals out and more days out. Other things you buy might go down: perhaps you stop buying the cheapest brand of noodles. Income changes the quantity demanded of different goods in different ways. In lesson 7 you saw that income is one of the things that can shift a demand curve. Now we measure how much demand moves when income changes.
This topic is examined on Paper 1 (Microeconomics and Business Economics), as part of section 1.1.4.
Key terms:
- Income elasticity of demand (YED): a measure of how much the quantity demanded of a good changes when consumers' income changes.
- Normal good: a good where demand rises when income rises (YED is positive).
- Luxury good: a normal good where demand rises by a bigger percentage than income (YED is above 1).
- Inferior good: a good where demand falls when income rises (YED is negative).
The YED formula
The formula looks just like the one for PED. The only change is the bottom line: it is income, not price.
Formula
YED = % change in quantity demanded ÷ % change in income
The letter Y is the economist's short way of writing income. If you are given the percentage changes, just divide. If you are given the actual numbers, work out each percentage change first:
Percentage change
% change = (new value − original value) ÷ original value × 100
Worked examples
Worked example 1: percentages given
Average income in a town rises by 10%. The quantity demanded of meals in restaurants rises by 15%.
YED = 15 ÷ 10 = +1.5
The number is above 1, so restaurant meals are a luxury good here. Demand rose by a bigger percentage than income.
Worked example 2: actual numbers given
Mara's monthly income rises from £1,500 to £1,800. Her takeaways each month rise from 4 to 6.
Step 1: % change in income = (1,800 − 1,500) ÷ 1,500 × 100 = 20%
Step 2: % change in quantity demanded = (6 − 4) ÷ 4 × 100 = 50%
Step 3: YED = 50 ÷ 20 = +2.5
Takeaways are a luxury good for Mara.
Worked example 3: income falls
Incomes in a region fall by 10%. The quantity demanded of foreign holidays falls by 20%.
YED = −20 ÷ −10 = +2.0
Two negatives divide to give a positive. Demand fell when income fell, so this is still a normal good, and a luxury one.
Reading the number
The size of the number tells you how sensitive demand is to income. The sign (plus or minus) tells you the type of good.
| YED value | Type of good | What happens when income rises |
|---|---|---|
| Above 1 (for example +2.5) | Luxury good | Demand rises by a bigger percentage than income |
| Positive (for example +0.4) | Normal good | Demand rises, but by a smaller percentage than income when the value is below 1 |
| Negative (for example −0.5) | Inferior good | Demand falls |
Notice that a luxury good is also a normal good, because its YED is positive. Normal goods with a YED between 0 and 1 are the everyday items people keep buying, such as bread. Demand for these still rises with income, just slowly.
💎 Luxury
YED above 1. Examples: foreign holidays, designer clothes, meals in restaurants. When incomes rise, people spend a bigger share of their income on these.
🛒 Normal
YED positive. Most goods and services fit here. When incomes rise, more is demanded. When incomes fall, less is demanded.
📱 Inferior
YED negative. Examples for many people: the cheapest value-range food, or travelling by bus when a car becomes affordable. People switch to better goods as income rises.
Worked examples: inferior goods
Value own-brand food is often an inferior good: people buy less of it when their income rises
Worked example 4: a negative answer
Incomes rise by 8%. The quantity demanded of a budget brand of instant noodles falls by 4%.
YED = −4 ÷ 8 = −0.5
The value is negative, so the noodles are an inferior good. Do not drop the minus sign. It is the whole answer.
Worked example 5: actual numbers, inferior
Income rises from £2,400 to £3,000 a month. A commuter's bus journeys fall from 40 to 30 a month.
% change in income = 600 ÷ 2,400 × 100 = 25%
% change in quantity demanded = −10 ÷ 40 × 100 = −25%
YED = −25 ÷ 25 = −1.0
Bus journeys are an inferior good for this commuter.
A good is not inferior because it is poor quality. It is inferior in the economist's sense only because demand falls as income rises. The same good can be inferior for one group of people and normal for another.
Common mistakes
- Dropping the minus sign. A negative YED means inferior, so the sign matters.
- Using price instead of income on the bottom of the formula. That gives PED, not YED.
- Using the new value as the base when finding a percentage change. Always divide by the original value.
- Thinking inferior means "bad quality" or that luxury means "expensive". They describe how demand reacts to income.
- Saying a luxury good is not a normal good. Luxury goods have a positive YED, so they are normal goods too.
Exam-style question
In the town of Hollin, average incomes rise by 5%. The table shows how the quantity demanded of three goods changes.
| Good | % change in income | % change in quantity demanded |
|---|---|---|
| A: theme park visits | +5% | +10% |
| B: bread | +5% | +2% |
| C: budget baked beans | +5% | −3% |
(a) Define income elasticity of demand. [2 marks]
(b) Calculate the income elasticity of demand for good A. Show your working. [2 marks]
(c) Calculate the income elasticity of demand for good C and state what type of good it is. [3 marks]
(d) Explain why good B is a normal good but not a luxury good. [2 marks]
Model answer
(a) Income elasticity of demand measures how much (1) the quantity demanded of a good changes when income changes (1).
(b) YED = % change in quantity demanded ÷ % change in income (1) = 10 ÷ 5 = +2.0 (1).
(c) YED = −3 ÷ 5 (1) = −0.6 (1). Budget baked beans are an inferior good because the YED is negative (1).
(d) Good B has a positive YED (2 ÷ 5 = +0.4), so demand rises when income rises (1). It is not a luxury good because the YED is below 1, so demand rises by a smaller percentage than income (1).
Exam tip
In a "calculate" part, write the formula first, then your numbers, then the answer with its sign. Even if the final number slips, the working can still earn marks.