income elasticity_of_demand

1. Income Elasticity of
Demand

2. iPhone sales set to be huge
 The iPhone is about to hit UK shelves,
with Carphone Warehouse predicting it
will be their busiest sales day ever.
 The Apple product combines a touch-
sensitive mobile phone handset with a
built-in iPod media player and a
wireless internet browser.
 It is already on eBay.co.uk for up to
double the £269 price tag it will carry
when it launches at 6.02pm on Friday.
 Many of the iPhones being sold by UK
vendors on the eBay online auction site
are described as unlocked, so they can
work on any mobile phone network.

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. 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. There are 3 different
types of Income Elastic
Goods

6. Income Elasticity of Demand:
 Normal Good – demand rises as income
rises and vice versa
 InferiorGood – demand falls as income
rises and vice versa

7. Look out for the sign…!
A positive sign (+) denotes a normal good
A negative sign (-) denotes an inferior good

8. The details you need to know
 Normal goods have a  Luxuries have an income
positive income elasticity of elasticity of demand > +1
demand
 So the demand rises more
 As consumers’ income rises, than proportionate to a
so more is demanded at each change in income
price level
 Inferior goods have a
negative income elasticity
 Normal goods have an of demand.
income elasticity of demand
of between 0 and +1  Demand falls as income
rises

9. The detailed
knowledge

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. Positive Income Elastic
Demand Diagram
 Note the axes are DIFFERENT!

12. Elastic or Inelastic + YeD
 Elastic goods – are  Inelastic goods – are
seen as LUXURIES OR seen as NORMAL or
SUPERIOR! NECESSITIES.

13. - Negative Income Elasticity
 Anincrease 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. 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. Negative Income Elasticity
Diagram = Inferior
 Note the different axes labels

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. So to summarise

18. Look for the signs!
NORMAL GOODS  LUXURY
GOODS
+ BETWEEN 0 & 1
+0.5 +0.9 + 0.1 + GREATER THAN 1
+2 +5 +27
INFERIOR GOODS
- CAN BE A DECIMAL OR A VALUE
GREATER THAN 1

19. For example:
 Yed = - 0.6:  Yed = + 1.6:
Good is an inferior good but Good is a normal good and
inelastic elastic
 a rise in income of 10% would  a rise in incomes of 10%
lead to demand falling by 6% would lead to demand rising
by 16%
 Yed = + 0.4:
Good is a normal good but
 Yed = - 2.1:
inelastic Good is an inferior good
 a rise in incomes of 10% would and elastic
lead to demand rising by 4%  a rise in incomes of 10%
would lead to a fall in
demand of 21%

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. You decide….
 Bus travel  Margarine
 Cigarettes  Stilton
 Designer clothes  Private education
 Fine wines  Private health care
 Fresh vegetables  Stringy cheese
 Frozen vegetables
 Rail travel
 Fruit juice
 Instant coffee
 Shampoo
 International air travel
 Tinned meat
 Luxury chocolates  Value “own-brand” bread

22. So which would have a a++value
So which would have value
So which would have a negative
GREATER THAN good?
0 AND 1?
BETWEEN inferior 1?
– value? i.e. an
i.e. a a LUXURY good?
i.e. NORMAL good?
 Bus travel  Margarine
 Cigarettes  Natural cheese
 Designer clothes  Private education
 Fine wines  Private health care
 Fresh vegetables  Processed cheese
 Frozen vegetables  Rail travel
 Fruit juice  Shampoo
 Instant coffee  Tinned meat
 International air travel  Value “own-brand” bread
 Luxury chocolates

23. A Diagram for you…

24. Relationship between Income
and Quantity Demanded
Quantity
Zero
income
elastici
ty Positive income elasticity Negative income elasticity
[inferior good]
0 y1 y2
Income

25. Income Elasticity of Demand for
Chocolate
Which country has
the sweeter tooth
when it comes to
Total consumption
income elasticity for
 USA 0.79 chocolate??
 Germany 0.39
 United Kingdom 0.44
 France 0.60
 Japan 0.08
 Switzerland 1.06
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. 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. Examples of YeD YeD mantra…
+ = normal
- = inferior!
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%
Your handout has
different figures…
 Yed = - 2.1: Good is an inferior goodannotate these to your
and elastic – a rise in
handout
incomes of 10% would lead to a fall in demand of 21%

28. Income Per Capita and Airline
100000
Travel by Country
Singapore
Hong Kong China
10000
New Zealand US
Australia Sw itzerland
Netherlands
ASK (000) per capita
Israel Canada
Denmark
Ecuador UK
Norw ay
Spain France Japan
Malaysia Finland
Saudi Arabia
Greece Ireland eden Belgium
Thailand Portugal Sw Germany
Austria
1000 Dominican Rep Panama Korea Rep
S. Africa Italy
Lebanon Chile
Costa Rica Mexico
Peru Brazil Venezuela
Philippines TunisiaHungary Argentina
Sri Lanka Colombia Why do you think
Kenya Zimbabw e Bulgaria Turkey Czech Rep
Uruguay New Zealand,
Cote D'IvoireSyria Croatia Slovenia
Lithuania Australia, Hong Kong
PakistanParaguay Romania Poland
100 and Singapore are
VietnamChinaAlgeria Iran above the trend line?
Cameroon Belarus
India Ukraine
Nigeria
Bangladesh
10
0 5000 10000 15000 20000 25000 30000 35000
GNP per capita ($ PPP)

29. Airlines – a Highly Cyclical
Industry What does this
mean?
Real GDP growth Global air traffic
% year on year % year on year
8 16
World real GDP growth (% vly)
World scheduled airline RPKs (% vly) 14
7
12
6
10
5
8
4 6
4
3
2
2
0
1
-2
0 -4
1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001

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. 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. Practice time….
This is NOT exam practice!
The exam paper will NOT look
like this!

33. Income elasticity of demands
in a recession
 Define YeD Product YeD
 What is the formula?
Luxury choc 2.4
Whisky 4.1
 What type of YeD
would you expect a Digestive 0.6
luxury good should Biscuits
have? Apples 0.2
 Identify the different Own brand -0.4
types of YeD in the baked beans
table…

34. Income elasticity of demands
in a recession
 Estimate the effect a Product YeD
5% fall in income would
have on each product. Luxury choc 2.4
Whisky 4.1
 Estimate the effect a
15% increase in Digestive 0.6
income would have on Biscuits
each product. Apples 0.2
Own brand -0.4
baked beans

35. Homework
RED sheet
Complete Questions