YED

Example of YED Puzzle at end of this Page

YED = Income Elasticity of Demand

Definition: The proportionate change in quantity demanded in respect of a proportionate change in income.

Income in this context means real income, that is, the purchasing power of the income - not necessarily the nominal value of the income.

Real Income is the purchasing power of income (i.e. how many litres of milk you can buy with your Punt), whereas nominal income means the number of Punts you receive as income.

We already know that changes in income of the population could bring about a change in the quantity demanded of a good, even though nothing has happened to the price of the good.

We know that as incomes rise, more of a good will tend to be bought, and that, as incomes fall, less will tend to be demanded. Goods which conform to this general trend are called Normal Goods if they have a downward left-to-right demand curve.

The demand curve for Normal Goods will shift to the right (upwards) away from the origin if there has been an increase in real income. The converse is also true. The demand curve will shift to the left if real income falls - bearing in mind that nothing has happened to the price of the good in question.

We can therefore deduce that INCOME ELASTICITY OF DEMAND for Normal Goods is positive.

An increase in income (plus) brings about an increase in demand (plus) for Normal Goods; a decrease in income (minus) results in a decrease in demand (minus) for normal goods. A plus by a plus will give us a plus, or a minus by a minus will give us a plus.

The sign for INCOME ELASTICITY OF DEMAND for Normal Goods is Positive.

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Example of INCOME ELASTICITY OF DEMAND:

Size of Real Income Demand for 25" Televisions

per week per week

Ł200 100

Ł300 200

Note that the income figures in the example are the average real income of the population, while the demand for the television sets is the demand of the population as a whole. Also note that nothing has happened to the price of the television sets. What we are measuring is the amount and direction of the shift in the demand curve.

The formula which we used for ARC PRICE ELASTICITY OF DEMAND will also, with a slight modification, be used for INCOME ELASTICITY OF DEMAND. If we replace P by Y, we have the formula for INCOME ELASTICITY OF DEMAND. (Y stands for Yield, which is the same thing as Income).

yed.gif (1429 bytes)

Ascribing the numbers of the example to this formula, we get

200 + 300 +100 +500 +5

--------- X ---- = ---- = ----

100 + 200 +100 +300 +3

= +1.66

We can see how the plus signs in the change in quantity and in the change of income have resulted in a plus sign, giving a Positive sign.

If the original income level had been Ł300 and it had fallen to Ł200, then the change in quantity and change in income figures would both have had minus signs. The "minus by the minus" would still give us a plus.

In Income Elasticity of Demand, the sign for Normal Goods is Positive.

This is, in fact, one of the essential elements in the definition of Normal Goods

"Normal goods have a positive income effect and a negative demand effect".

Any goods which are not Normal, are Inferior goods.

An excellent example of Inferior goods is that of remould tyres. As the population's income increases, the demand for remould tyres would tend to decrease. The income increase (plus) brings about a decrease in the quantity demanded (minus), all other things being equal. This "plus by a minus" will give us a minus.

In INCOME ELASTICITY OF DEMAND, the sign for Inferior goods is negative.

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