Meaning of income elasticity of demand
Income elasticity of demand (YED) measures the percentage change in quantity demanded due to the percentage change in the consumer’s income. It is calculated thus:
% change in quantity demanded
YED = ________________________________
% change in income
% change in quantity demanded
= New quantity – Old quantity 100
______________________ X ___
Old quantity 1
% change in income
= New income – Old income 100
__________________________ X ___
Old income 1
Worked example on YED
Calculate the YED if the quantity demanded increased from 4,000 to 4,800 due to a rise in income from $100,000 to $150,000.
Solution
New quantity = 4,800 Old quantity = 4,000
New income = $150,000 Old income = $100,000
PED = 4,800 – 4,000 X 100
__________ ____
4,000 1
____________________
150,000– 100,000 100
_____________ X ____
100,000 1
= 20%
____
50%
= 0.4
Interpretation of YED values
YED is positive
It means that the quantity demanded is directly related to income. If income is increased, quantity demanded will increase. Also, quantity demanded decreases as income decreases. This is the characteristic of a normal good.
YED is negative
A negative value indicates that the good is an inferior good, i.e. quantity demanded and income are inversely related. A fall in income leads to a rise in quantity demanded while an income rise results in a fall in quantity demanded.
YED is greater than 1 (normal good with elastic demand)
A value greater than 1 means that the good is normal. In addition, the good is elastic as an income increase will lead to a greater increase in quantity demanded while a fall in income will result in a greater fall in quantity demanded.
YED is between 0 and 1 (normal good with inelastic demand)
This means that it is a normal good with inelastic demand. An income increase will lead to a smaller increase in quantity demanded while a fall in income will result in a smaller fall in quantity demanded.
YED is less than 0
This means that the YED is negative. It is an inferior good. If the magnitude of the YED is less than 1,e.g., -0.5, the good is an inferior good with inelastic demand. So a change in income leads to a smaller change in quantity demanded. If YED is say -2, the negative sign shows it is an inferior good. The magnitude of 2 shows that a change in income brings about a greater change in quantity demanded.