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Income elasticity of demand

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Income elasticity of demand (Yed) measures the relationship between a change in quantity demanded and a change in real income

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Income elasticity of demand

  1. 1. Income Elasticity of Demand Prepared By: Milan Padariya
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  3. 3. Aims:  To understanding the concept of YeD  To have written and numerate understanding of elasticity figures (elastic & inelastic)  To understand the implications for revenue and profit (and therefore decision-making);
  4. 4. Formula  Income elasticity of demand (Yed) measures the relationship between a change in quantity demanded and a change in real income  Yed = % change in demand % change in income
  5. 5. There are 3 different types of Income Elastic Goods
  6. 6. Income Elasticity of Demand:  Normal Good – demand rises as income rises and vice versa  Inferior Good – demand falls as income rises and vice versa
  7. 7. Look out for the sign…! A positive sign (+) denotes a normal good A negative sign (-) denotes an inferior good
  8. 8. The details you need to know  Normal goods have a positive income elasticity of demand So the demand rises more than proportionate to a change in income   Luxuries have an income elasticity of demand > +1    Inferior goods have a negative income elasticity of demand.  Demand falls as income rises As consumers’ income rises, so more is demanded at each price level Normal goods have an income elasticity of demand of between 0 and +1
  9. 9. The detailed knowledge
  10. 10. + Positive Income Elasticity A rise in income will cause a rise in demand A fall in income will cause a fall in demand  Coffee example…. A 10% increase in income will result in a 2.3% increase in demand for coffee.  What’s the YeD?  What will this look like on a D & S diagram?
  11. 11. Positive Income Elastic Demand Diagram  Note the axes are DIFFERENT!
  12. 12. Elastic or Inelastic + YeD  Elastic goods – are seen as LUXURIES OR SUPERIOR!  Inelastic goods – are seen as NORMAL or NECESSITIES.
  13. 13. - Negative Income Elasticity  An increase in income will result in a decrease in demand. A decrease in income will result in a rise in demand.  ALSO known as INFERIOR GOODS
  14. 14. Negative Income Elasticity  Potatoes are seen as a inferior product  Potatoes have a YeD of -0.48  So a 10% rise in incomes will result in????  What would this look like on a D&S diagram?
  15. 15. Negative Income Elasticity Diagram = Inferior  Note the different axes labels
  16. 16. Zero Income Elasticity  This occurs when a change in income has NO effect on the demand for goods.  A rise of 5% income in a rich country will leave the Demand for toothpaste unchanged!
  17. 17. So to summarise
  18. 18. Look for the signs! NORMAL + GOODS  + BETWEEN 0 & 1 +0.5 +0.9 + 0.1 INFERIOR - LUXURY GOODS GREATER THAN 1 +2 +5 +27 GOODS CAN BE A DECIMAL OR A VALUE GREATER THAN 1
  19. 19. For example:     Yed = - 0.6: Good is an inferior good but inelastic a rise in income of 10% would lead to demand falling by 6% Yed = + 0.4: Good is a normal good but inelastic a rise in incomes of 10% would lead to demand rising by 4%     Yed = + 1.6: Good is a normal good and elastic a rise in incomes of 10% would lead to demand rising by 16% Yed = - 2.1: Good is an inferior good and elastic a rise in incomes of 10% would lead to a fall in demand of 21%
  20. 20. So what’s a Normal, a Luxury and an Inferior good? In groups of 3’s … You will each be ‘given’ a set of goods and you have to decide whether each is a normal, luxury or an inferior good…
  21. 21. You decide….           Bus travel Cigarettes Designer clothes Fine wines Fresh vegetables Frozen vegetables Fruit juice Instant coffee International air travel Luxury chocolates          Margarine Stilton Private education Private health care Stringy cheese Rail travel Shampoo Tinned meat Value “own-brand” bread
  22. 22. So which would have value So which would have a negative So which would have a a++value GREATER THAN good? BETWEEN inferior 1? 0 AND 1? – value? i.e. an i.e. NORMAL good? i.e. a a LUXURY good?           Bus travel Cigarettes Designer clothes Fine wines Fresh vegetables Frozen vegetables Fruit juice Instant coffee International air travel Luxury chocolates          Margarine Natural cheese Private education Private health care Processed cheese Rail travel Shampoo Tinned meat Value “own-brand” bread
  23. 23. A Diagram for you…
  24. 24. Quantity Relationship between Income and Quantity Demanded Zero income elastici ty 0 Negative income elasticity [inferior good] Positive income elasticity y1 Income y2
  25. 25. Income Elasticity of Demand for Chocolate Total consumption  USA 0.79  Germany 0.39  United Kingdom 0.44  France 0.60  Japan 0.08  Switzerland 1.06 Which country has the sweeter tooth when it comes to income elasticity for chocolate?? Reference: Henri Jason Trends in cocoa and chocolate consumption with particular reference to developments in the major markets. Malaysian International Cocoa Conference, Kuala Lumpur, 20-21 October 1994 (ICCO, ED(MEM) 686)
  26. 26. Income Elasticity and the Demand for Airline Travel  Demand for air travel has a positive income elasticity of demand  The industry is cyclical  During an upturn, demand rises for business and leisure travel)  During a recession, the demand tails away  In the long run, there is a positive relationship between real GDP per capita and the demand for air travel  Income elasticity will vary according to the type of air travel  E.g. difference between low-cost “no-frills” and higher priced scheduled services on low-haul flights
  27. 27. Examples of YeD For example: YeD mantra… + = normal - = inferior!  Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 10% would lead to demand falling by 6%  Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 10% would lead to demand rising by 4%  Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 10% would lead to demand rising by 16%  Your handout has different figures… annotate these to your good andhandout – a elastic Yed = - 2.1: Good is an inferior rise in incomes of 10% would lead to a fall in demand of 21%
  28. 28. Income Per Capita and Airline Travel by Country 100000 Singapore Hong Kong China ASK (000) per capita 10000 New Zealand Australia Sw itzerland US Netherlands Canada Denmark UK Norw ay Spain France Japan Malaysia Finland Belgium Saudi Arabia Greece Ireland eden Germany Sw Portugal Austria Thailand Panama Korea Rep Dominican Rep 1000 Italy S. Africa Lebanon Chile Costa Rica Mexico Brazil Venezuela Peru Philippines TunisiaHungary Argentina Sri Lanka Colombia Why do you think Czech Rep Zimbabw e Kenya Bulgaria Turkey Uruguay New Zealand, Cote D'IvoireSyria Croatia Slovenia Lithuania Australia, Hong Kong Pakistan Paraguay Romania Poland Israel Ecuador 100 and Singapore are above the trend line? VietnamChinaAlgeria Iran Cameroon Belarus India Ukraine Nigeria Bangladesh 10 0 5000 10000 15000 20000 GNP per capita ($ PPP) 25000 30000 35000
  29. 29. Airlines – a Highly Cyclical What does this Industry mean? Global air traffic % year on year Real GDP growth % year on year 8 16 World real GDP growth (% vly) World scheduled airline RPKs (% vly) 7 14 12 6 10 5 8 4 6 4 3 2 2 0 1 -2 0 1971 -4 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001
  30. 30. Significance of Income Elasticity of Demand  High Income Elasticity  Demand is sensitive to changes in real incomes  Demand is therefore cyclical – in an economic expansion, demand will grow strongly. In a recession demand may fall  Can be difficult for businesses to accurately forecast demand and make capital investment decisions
  31. 31. Significance of Income Elasticity of Demand  Low Income Elasticity  Demand is more stable during fluctuations in the economic cycle  Over time, the share of consumer spending on inferior goods and normal necessities tends to decline  Long run – businesses need to invest in / focus on products with a higher income elasticity of demand if they want to increase total profits
  32. 32. Practice time…. This is NOT exam practice! The exam paper will NOT look like this!
  33. 33. Income elasticity of demands in a recession  Define YeD Product  What is the formula? Luxury choc 2.4 Whisky 4.1 Digestive Biscuits 0.6 Apples 0.2 Own brand baked beans -0.4   What type of YeD would you expect a luxury good should have? Identify the different types of YeD in the table… YeD
  34. 34. Income elasticity of demands in a recession   Estimate the effect a 5% fall in income would have on each product. Estimate the effect a 15% increase in income would have on each product. Product YeD Luxury choc 2.4 Whisky 4.1 Digestive Biscuits 0.6 Apples 0.2 Own brand baked beans -0.4

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