Yr 11 ECON Wk 8
INCOME ELASTICITY OF DEMAND
SYLLABUS OUTCOMES:
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Define income elasticity of demand YED
Calculate YED using the equation
Show that normal goods have a positive value of YED and inferior goods have a negative value
of YED.
Distinguish, with reference to YED, between necessity (income inelastic) goods and luxury
(income elastic) goods.
THE DEFINITION:
Income elasticity of demand is a measure of the responsiveness of demand to a change in
income. It provides information on the direction of change of demand given a change in
income and the magnitude of the change (by how much the demand curve will shift).
The impact of income on demand depends on whether the good being considered is a
normal or an inferior good.

For normal goods – income and demand will change in the same direction. This
means:

 If income rises
demand _______
D shifts _______
 If income falls
demand _______
D shifts _______
For inferior goods – income and demand will change in the opposite direction. This
means:
 If income rises
demand _______
D shifts _______
 If income falls
demand _______
D shifts _______
THE FORMULA:
Percentage Change in the
Quantity demanded of a
good
YED = ______________________________
YED = _______ = YED = _____________________
Percentage Change in
Income
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Yr 11 ECON Wk 8
INTERPRETING THE INCOME ELASTICITY OF DEMAND (YED)
YED provides 2 kinds of important information:
a. Its sign ( whether its positive or negative)
b. Its numerical value (whether it is high or small)
The Sign
+ve YED > 0
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Interpretation of sign
Demand and income change in the
same direction
The good demanded is a normal
good
Eg: most goods are normal goods
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-ve YED < 0
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Demand and income change in the
opposite direction
The good demanded is an inferior
good
Eg: bus rides, used clothes, cheap
meat
THE DIAGRAM
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Value of sign
If YED > 1
Good is income elastic
A % change in income
results in a large change in
demand
Numerator larger than
denominator in formula
If YED < 1
Good is income inelastic
A % change in income
results in a small change in
demand
Numerator is smaller than
denominator in formula
Yr 11 ECON Wk 8
The diagram shows an initial demand curve D1 and shifts of the D curve that occur in
response to increases in income, depending on the sign and the value of the YED.

If YED –ve indicating an _________ good, an increase in Y caused D curve to shift
__________ to _______
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If YED +ve indicating a _________ good, an increase in Y caused D curve to shift
__________ to _______ or D4
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The greater the +ve YED the larger is the right shift of the demand curve
TEST YOUR UNDERSTANDING
1. Your income increases from $ 1000 a month to $1200 a month. As a result you
increase your purchases of pizzas from 8 to 12 Pizzas per month and you
decrease your purchases of cheese sandwiches from 15 to 10 sandwiches per
month.
a. Calculate YED for pizza and cheese sandwiches
b. What kind of goods are pizzas and cheese sandwiches?
c. Show diagrammatically the impacts of your increase in income on your
demand for pizza and cheese sandwiches.
2. A 15% increase in income leads to a 10% increase in demand for good A and 20%
increase in demand for good B. Explain which of the two goods is income elastic
and which is income inelastic
THE DETERMINANTS OF INCOME ELASTICITY OF DEMAND
Assuming that YED >0 (ie for normal goods) the following factors determine
whether the YED will be HIGH or LOW
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NECESSITIES
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The most important determinant because necessities like food,
clothing and shelter tend to have 0<YED<1 (ie income inelastic)
In the case of food, as Y rises, people buy more food but the
proportion spent on food increases at a SLOWER rate than the
increase in Y
In developing countries YED for food is about 0.15 to 0.2. this
means a 1% increase in Y results in 0.15% to 0.2% increase in
spending on food
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Yr 11 ECON Wk 8
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LUXURIES
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INCOME
LEVLELS OF
CONSUMERS
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Luxuries like traveling, private education and eating in
restaurants have YED >1 (income elastic).
This means as Y increases; proportion of Y spent on such goods
increases at higher rates than income
What is necessity and luxury good depends on the income of
consumers.
For people with very low Y, food, and clothing can be luxuries –
ie as Y increases certain items that used to be luxuries become
necessities Eg: Coca Cola and coffee in poor countries are
luxuries whereas for rich countries they are a necessity
YED for certain goods therefore varies widely depending on Y
levels
Test Your Understanding:
1. What do you think is likely to have happened to the YED for laptops since they
were first introduced
2. Explain why YED for food has been estimated to be about 0.15 to 0.2 in more
developing countries and about 0.8 in less developed countries
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