Income Elasticity of Demand (H2 Only)

*Note: This topic is for H2 Economics only.

So what exactly is income elasticity of demand? Can it be stretched like rubber band? And why is it short-formed “YED” ?

Similar to the Price Elasticity of Demand “PED” (previous topic), YED shows the extent / magnitude of a consumption of a good in response to a change in INCOME. For example, during the Chinese New Year season, when you receive more “Ang Bao”, what good will you tend to buy more i.e Playstation Portable etc? What good will you tend to buy less i.e eating lesser hawker food and eating more at fancy restaurants?

However unlike PED which is always negative, YED can be either negative or positive:

1. YED < 0 – a 1% increase (fall) in income will lead to a fall  (increase) in quantity demanded;
2. 0 < YED < 1 – a 1% increase (fall) in income will lead to a LESS than 1% increase (fall)  in quantity demanded;
3. YED > 1 – a 1% increase (fall) in income will lead to a MORE than 1 % increase (fall)  in quantity demanded.

So what does all this confusing signs mean? And how does it apply to my a level econs essays / case studies?

1. Case Studies – you may be tested on the definition and interpretation of tables with all these numerical examples;

2. Essays – You are expected to identify these goods as inferior / necessity / luxury good respectively and apply economics analysis. Favourite questions involve “role-playing” as a business owner and how does YED relates to your business decision.

Let us try to identify & simplify the complex numbers above!

1. YED < 0 – Inferior Good i.e instant noodle. An increase in your income will lead to a fall in consumption of instant noodle . Would you be consuming more miserable Maggi Mee when you receive a pay raise?;
2. 0 < YED < 1 – Necessity Good i.e Rice. A 1% increase in your income will lead to a less than 1% increase in consumption of Rice (you still need rice everyday anyway);
3. YED > 1 – Luxury Good i.e Luxury bags like LV. A 1% increase in your consumption will lead to more than 1% increase in buying of LV bags. Imagine receiving your first huge bonus from your job. How would you spend it?

So why should you know about YED? For example, if you are Steve Jobs, where will you open your next Apple Store? Is it the up & coming China?

Or issit the poverty – stricken North Korea?

The answer is definitely China. Because of the nature of iPhone (luxury goods), an increase in Chinese’s income will lead to a more than proportionate increase in iPhone in China! That is why Apple is busy building iPhone and iPad Assembly Plants in China!

So now after going through all these, can you also explain why there are significantly more movie screening in the theatre during Chinese New Year Period? This is because students like yourselves will be receiving alot of Ang Baos and contributing them to shows filmed by Jacky Chan! Oh yes, lastly, ever wondered why issit YED and not IED? It is because Economist like to use Y to denote income

In our regular economics lesson, we will be using simple yet engaging explanations like these to illustrate economics concepts. Find out more!