YED

INCOME ELASTICITY OF DEMAND

RESPONSIVENESS / SENSITIVITY / BEHAVIOR OF THE QUANTITY DEMAND TO CHANGE IN THE INCOME.

EXAM REQUIREMENTS:

CALCULATION AND INTERPRETATION OF THE RESULT

TYPES OF GOODS AS REPRESENTED BY THE YED
DIAGRAMS
APPLICATION OF YED

1. CALCULATION:

YED = % CHANGE IN QD
% CHANGE IN INCOME

WHERE % CHANGE = CHANGE X 100

ORIGINAL VALUE

EXAMPLE 1:

INCOME CHANGE : $1000 TO $1200 [+200/1000 X 100 = +20%]

CHANGE IN QD OF GOOD A : 50 UNITS TO 70 UNITS [+20/50 X 100 = +40%]

YED = % CHANGE IN QD +40% = + 2 [THE ANSWER 2 IS GREATER THAN 1, HENCE ELASTIC]

% CHANGE IN PRICE +20%

EXAMPLE 2:

INCOME CHANGE : $500 TO $700 [+200/500 X 100 = +40%]

CHANGE IN QD OF GOOD A : 50 UNITS TO 40 UNITS [-10/50 X 100 = -20%]

YED = % CHANGE IN QD -20% = - 0.5 [THE ANSWER 0.5 IS LESS THAN 1, HENCE INELASTIC]
% CHANGE IN PRICE +40%

2. CONCEPT OF INCOME ELASTICITY OF DEMAND CAN BE USED TO MAKE A DISTINCTION BETWEEN DIFFERENT
TYPES OF GOODS
 (I) NORMAL GOODS INFERIOR GOODS
EXISTANCE OF POSITIVE/DIRECT (II) EXISTANCE OF NEGATIVE/INVERSE
RELATIONSHIP BETWEEN THE INCOME RELATIONSHIP BETWEEN THE INCOME
AND THE QUANTITY DEMANDED SHOWS AND THE QUANTITY DEMANDED SHOWS
THAT THE GOODS IS A NORMAL GOOD. THAT THE GOODS IS AN INFERIOR GOOD.
THIS MEANS THAT THIS MEANS THAT
RISE IN INCOME TO CAUSE QD INCREASE RISE IN INCOME TO CAUSE QD DECREASE
AND AND
FALL IN INCOME TO CAUSE QD DECREASE FALL IN INCOME TO CAUSE QD INCREASE

INCOME QD INCOME QD

+ -

SUCH GOOD IS USUALLY A HIGH VALUE SUCH GOOD IS USUALLY A LOW VALUE
NORMAL GOOD WHICH THE INFERIOR GOOD WHICH THE
CUSTOMERS PURCHASE MORE AS THEIR CUSTOMERS PURCHASE MORE AS THEIR
INCOMES RISE INCOMES FALL (CHEAPER GOODS)
AND AND
PURCHASE LESS AS THE INCOMES FALL. PURCHASE LESS AS THE INCOMES RISE.
(SWITCH TO BETTER NORMAL GOODS)

EXAMPLES: LUXURY HOUSING, ELECTRONIC ITEMS EXAMPLES: BICYCLES AND PUBLIC TRANSPORT FOR
SUCH AS LAPTOPS AND FITNESS TRACKERS, PRIVATE TRAVELLING, SECOND-HAND FURNISHING AND
(PERSONAL CARS) ETC. (POSITIVE RELATIONSHIP : CLOTHING ETC.(NEGATIVE RELATIONSHIP: DOWNARD
UPWARD SLOPING DEMAND CURVE) SLOPING DEMAND CURVE).

INCOME D
INCOME
Y1 Y1

Y Y

0 Q Q1 QUANTITY
0 Q1 Q QUANTITY

Y Y Y Y
FLATTER STEEPER FLATTER STEEPER
Y1 Y1 Y1 Y1
Y
Y Y Y
D D

0 Q Q1 Q 0 Q Q1 Q 0 Q1 Q Q 0 Q1 Q Q

INCOME CHANGE : + 20% INCOME CHANGE : + 20% INCOME CHANGE : + 20% INCOME CHANGE : + 20%
QD CHANGE : +40% QD CHANGE : +10% QD CHANGE : - 40% QD CHANGE : -10%
YED = +40%/20% = +2 (ELASTIC) YED= +10%/20% = +0.5 (INELASTIC) YED = -40%/20% = -2 (ELASTIC) YED = -10%/20% = -0.5 (INELASTIC)
 PRACTICE (YED VALUE INTERPRETATION AND TYPE OF THE GOOD)

YED RELEVENANT FIGURE ELASTICITY NORMAL / INFERIOR

+2.5 B ELASTIC NORMAL

ELASTIC
-2.25 A INFERIOR

+0.5 C INELASTIC NORMAL

E INELASTIC
-0.1 INFERIOR

0 D PERFECTLY INELASTIC -

Y Y D Y Y D Y

D D

0 Q 0 Q 0 Q 0 Q 0 Q

A B C D E

APPLICATION OF YED BY THE BUSINESSES

PRODUCERS MANAGE TO DECIDE ABOUT THE TYPE OF THE PRODUCT TO BE PRODUCED ACCORDING TO
THE ECONOMIC CONDITIONS.

DURING ECONOMIC GROWTH, PEOPLE EXPERIENCE A RISE IN THEIR INCOMES AND ARE LIKELY TO DEMAND
MORE OF HIGH VALUE NORMAL GOODS. HENCE PRODUCERS OF HIGH VALUE NORMAL GOODS TO GAIN
BUSINESS DURING ECONOMIC GROWTH WHEREAS PRODUCERS OF LOW VALUE INFERIOR GOOD ARE
LIKELY TO FACE A FALL IN SALES.

ON THE OTHER HAND, ECONOMIC RECESSION BRINGS A FALL IN THE SALES OF THE PRODUCERS OF
NORMAL GOODS BUT MAKE THE PRODUCERS OF LOW VALUE INFERIOR GOODS TO GAIN.

THIS SUGGESTS THAT THE PRODUCERS SHOULD BE HAVING THE CAPACITIES TO PRODUCE BOTH HIGH
VALUE NORMAL GOODS AND LOW VALUE CONSUMER GOODS TO SURVIVE AND DO GOOD BUSINESS IN
LINES WITH THE REQUIREMENTS OF THE ECONOMIC CONDITIONS.