Income elasticity of demand measures the responsiveness of demand for a good to changes in consumer income. Normal goods have positive income elasticity, meaning demand increases as income rises, while inferior goods have negative elasticity as people switch to other goods when income is higher. Necessities have income elasticity between 0 and 1, while luxuries have income elasticity greater than 1. Cross elasticity of demand measures the responsiveness of demand for one good to price changes of another good, being positive for substitutes and negative for complements. Firms and governments are interested in elasticities to understand how demand may change with income or competitor prices.

1. Other types of Elasticity
Income Elasticity of Demand
Cross Elasticity of Demand

2. Income Elasticity of
Demand
The responsiveness
of demand to
changes in consumer
income.

3. Income Elasticity of
Demand
Normal Good – quantity demanded rises as
income rises and vice versa (direct relationship)
A positive sign denotes a normal good
Those with sufficient income will generally opt to buy a normal
good.
individuals who have a low income come into extra money, such
as a raise, a bonus or a win (via lottery or casino, for example),
they may treat themselves by purchasing normal goods.
However, if a consumer's income goes down (such as due to a
job loss or inability to work due to illness or injury), then the
person's demand for normal goods will also go down.
3 Egs are:

4. Income Elasticity of
Demand
Inferior Good – quantity demanded falls as
income rises and vice versa
A negative sign denotes an inferior good
• Consumers who consistently maintain a low-income level
tend to purchase inferior goods most or all of the time.
• When people experience a loss in income, they will shift
to purchasing inferior goods out of necessity until their
income rises.
3 Egs are:

5. Income Elasticity of
Demand
Necessities have an income elasticity of
demand of between 0 and +1.
Demand is not very sensitive at all to changes in
income so demand for these products is
relatively stable when income changes.
3 Egs are:

7. Income Elasticity of
Demand
Luxuries on the other hand are said to have an
income elasticity of demand > +1
In a recession or economic slowdown, these
items might be the first victims of decisions by
consumers to rein in their spending.
3 Egs are:

8. Income Elasticity of
Demand
Equation is similar to the usual but instead of price
we are concerned with income.
YED = % change in Q
% change in Y
YED = ΔQ
Qave
____________
ΔY
Yave

9. Income Elasticity of
Demand
JUST IN CASE YOU HAVE
NOT NOTICED
THE SIGN (+/-) MATTERS

10. Different income elasticities
YED TERM INTERPRETATION
Positive Normal Product For most products, extra
income increases demand
Greater than 1 Luxury product, income
elastic
Consumers spend their extra
money on these product
Between 0 and 1 Necessity, income elastic Consumers were already
buying necessities
Negative Inferior As income rises consumers
switch to better products

11. Elasticity
For example:
Yed = - 0.6: Good is an inferior good but inelastic – a
rise in income of 3% would lead to demand falling by
1.8%
Yed = + 0.4: Good is a normal good but inelastic – a
rise in incomes of 3% would lead to demand rising by
1.2%
• Yed = + 1.6: Good is a normal good and elastic – a rise
in incomes of 3% would lead to demand rising by 4.8%
Yed = - 2.1: Good is an inferior good and elastic – a
rise in incomes of 3% would lead to a fall in demand of
6.3%

12. Income Elasticity of
Demand
Examples to practice:
1. If the consumption of new cars fell by 20% after a 10% fall
in income, calculate the YED.
Yed = + 2 Good is a normal good and elastic
2. If a consumers income rose from $1500 per week to $1700
and their weekly porterhouse steak consumption rose from
4 to 6, calculate the YED
Yed = +3.84 Good is a normal good and elastic
3. If consumers went from buying 20 – 18 sausages per
month after an increase in income from $3500 - $4500,
calculate the YED.
Yed = - 0.38 Good is an inferior good but inelastic

13. Income Elasticity of
Demand
Importance: Business owners, Share owners
2 companies: Oroton and The Reject Shop
Discuss how the income elasticity of demand will
affect the goods these 2 companies sell. (Look
them up on the web if you don’t know)
How would they have fared during a recession
like COVID?

14. Who is interested in the level
of income elasticity?
Firms will be interested in how the demand for their
products is affected by changes in incomes, (the business
cycle).
Households maybe interested in how a change in income
will affect their budget.
Income elasticity indicates the extent of the change in
budget share for a particular product.
Governments will be interested in income elasticity.
As incomes rise the pattern of spending changes.
This will alter the relative sizes of sectors in the economy
and lead to structural changes.

15. Cross Elasticity of
Demand
The responsiveness of
demand of one good to
changes in the price of a
related good – either a
substitute or a complement

16. Cross Elasticity of Demand
Equation is similar to the usual but we now compare the
change in Q of one good to the change in P of another good.
XED = % change in Q of good A
% change in P of good B
XED = ΔQ GOOD A
Qave
____________
ΔP GOOD B
Pave

17. Cross Elasticity of Demand
JUST IN CASE YOU HAVE
NOT NOTICED
THE SIGN (+/-) MATTERS

18. Cross Elasticity of Demand
Goods which are
complements:
Cross Elasticity will have negative
sign (inverse relationship between the
two)
E.G.
Goods which are substitutes:
Cross Elasticity will have a positive
sign (positive relationship between the
two)

19. Cross Elasticity of Demand
The larger the coefficient is the stronger the
relationship. Note we don’t say elastic or inelastic
here.
Note that not all good and services are either a
substitute or a compliment to each other. When
the coefficient is close to zero, we say that there
is no relationship.

20. Cross Elasticity of Demand
Calculate the XED and comment on the relationship
when:
1. The quantity demanded of MacBook Air’s fell by 20%
after a 30% fall in the price of Windows Surface
Xed = + 0.66 substitute
2. The quantity demanded for cars increases from 200
to 300, as the price of petrol falls from $1.65 per litre
to $1.25.
Xed = - 2.08 complementary good
3. The price of widgets increases from $2 to $4 and the
quantity demanded of hats changes from 3000 to
3100.
Xed = 0.033 that there is no relationship.