Income Elasticity of Demand

Price elasticity of demand measures the degree of responsiveness of quantity demanded of a good X to a given change to a price of itself, ceteris paribus. Price elasticity of demand is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price. When PED is greater than one (PED > 1) demand is said to be elastic When PED is between zero to one (0 > PED > 1) demand in said to be inelastic When PED is equal to one (PED > 1) demand is said to be unit-elastic (unitary elasticity) A perfectly inelastic demand curve, perpendicular to the X-axis, has zero elasticity. A perfectly elastic demand curve, horizontal to X axis, is infinitely elastic. The price elasticity of demand for a particular demand curve is influenced by the following factors: Availability of substitutes: the greater the number of substitute products, the greater the elasticity. Degree of necessity or luxury: luxury products tend to have greater elasticity than necessities. Some products that initially have a low degree of necessity are habit forming and can become â€Å"necessities† to some consumers. Proportion of income required by the item: products requiring a larger portion of the consumer's income tend to have greater elasticity. †¢ Time period considered: elasticity tends to be greater over the long run because consumers have more time to adjust their behavoir to price changes. Income elasticity of demand measure the degree of responsiveness of quantity demanded of good X to a given change in level of income, ceteris paribus. Income elasticity of demand is calculated by dividing the proportionate change in quantity demanded by the proportionate change in level of income. When YED is less than one (YED ; 1) demand is income inelastic. When YED is greater than one (YED ; 1) demand is income elastic. If YED is negative (YED ; 0) the good is sometimes referred to as an inferior good as opposed to normal goods ( 0 ; YED ; 1) and superior ( luxury ) goods (YED;1). The income elasticity of demand for a particular demand curve is influenced by the following factors: †¢ Need of good ( Basic necessity or luxury good ) †¢ Level of income †¢ Time factor One reason for this is that as a society becomes richer, there are changes in consumer perceptions about different goods and services together with changes in consumer tastes and preferences. What might have been considered a luxury good several years ago might now be regarded as a necessity Income Elasticity of Demand Income Elasticity of Demand is a measure of responsiveness of demand to the changes in income and it involves demand curve shifts. It provides information on the direction of change of demand, given a change in income and the size of the change. Formula for YED: Percentage change in quantity demanded = %?Q Percentage change in income %?Y Normal goods have a positive value of YED, while Inferior goods have a negative value of YED as shown in the graph below: Normal goods: when income increases, demand for normal goods increases as well. An increase in income leads to an increase in consumption, demand shifts to the right Inferior goods: when income increases, demand for this good falls. The demand curve shifts left as income rises. As income rises, the proportion spent on food tends to fall while the proportion spent on services tends to rise. Necessity and Luxury goods Necessity YED 1 If a good has a YED that is greater than one, is has income elastic demand: a percentage increase in income produces a larger percentage increase in quantity demanded. Luxuries are income elastic goods. Like the I Phone or chewing gum. Applications of Income and elasticity of demand YED implication for producers and for the economy Overt time the economy grows and the society’s income increases. Increasing income means a rising demand for goods and services. If the average economic growth is 3% per year, goods and services have income elastic demand (YED >1) thus, the demand of these goods and services grows at a higher rate than 3%. Examples include Restaurants, Movies and Health care, (these goods and services are produced by industries that develop and expand more rapidly than the total income in the economy). Also the demands of other goods such as food, clothing and furniture which are inelastic have a rate of less than 3%, (these goods and services are produced by industries growing more slowly than total income). Higher YED greater future expansion Lower YED Smaller future expansion This means that before you may produce a good think about the YED. The three parts of an Economy Primary sector agriculture, forestry, fishing and extractive industries. Positive YED thus is income inelastic. * Manufacturing sector textile and appliances. Income elastic Negative YED. * Service sector entertainment, insurance and education. Higher YED, greater percentage increase in the demand. Hence as the total output of agricultural shares in the economy drops, the share manufactured output grows. Through continuous growth, t he service sector expands at the expense of both agriculture and manufacturing as shown in the diagram below: Less economically developed countries have a larger primary sector while developed countries are dominated by services. **Remember that if the total output increases over time, a falling share of a certain sector (like the primary sector) does not automatically mean that the output is reducing, probably the sectors output is growing but slower than the total output. An increasing share for a sector means that its output is growing more rapidly than the total output.