BOUNOMICS - 2.5.2 YED

<INCOME ELASTICITY OF DEMAND [YED]>

--YED: DEFINITION--

INCOME ELASTICITY OF DEMAND (YED) Is a measure of the RESPONSIVENESS OF DEMAND TO A CHANGE IN INCOME and involves DEMAND CURVE SHIFTS.
It PROVIDES INFORMATION on the DIRECTION OF THE CHANGE, (POSITIVE or NEGATIVE) as well as the SIZE OF THE CHANGE (ELASTIC or UNELASTIC)

--YED: FORMULA--

--YED: QUICK CALCULATION--

--YED: SIGNS & VALUES--

--POSITIVE--

When the YED > 0 Income elasticity of demand is POSITIVE, meaning DEMAND and INCOME change in the SAME DIRECTION (i.e. both increase or both decrease). A positive YED indicates that the good in question is A NORMAL GOOD.

--NEGATIVE--

When the YED < 0 Income elasticity of demand is NEGATIVE, meaning DEMAND and INCOME change in OPPOSITE DIRECTIONS (i.e. when income increases, demand decreases, and vice versa). A negative YED indicates that the good in question is AN INFERIOR GOOD.

--POSITIVE < 1--

When the YED is POSITIVE and also LESS THAN ONE it has INCOME INELASTIC DEMND (a % increase in income produces a SMALLER % increase in Qd. NECESSITIES are income inelastic goods. E.g. Food, clothing and housing..

--POSITIVE > 1--

When the YED is POSITIVE and also GREATER THAN ONE it has INCOME ELASTIC DEMAND (a % increase in income produces a LARGER % increase in Qd. LUXURIES are income elastic goods. E.g. Foreign holidays, private education, sports cars...

--THE ENGEL CURVE [HL ONLY]--

--DEFINITION--

ENGEL'S LAW is an economic relationship proposed by the statistician Ernst Engel in 1857. It suggests that as FAMILY INCOME INCREASES, the following is most often observed:
- - - - 1) As TOTAL EXPENDITURE on 'FOODSTUFFS' INCREASES, the % of TOTAL INCOME SPENT DECREASES.
        2) The TOTAL EXPENDITURE on 'HOUSING AND CLOTHING' INCRERASES, but stays PROPORTIONALLY THE SAME, as a % of TOTAL INCOME SPENT
        3) As TOTAL EXPENDITURE on 'EDUCATION AND HEALTHCARE' INCREASES, however, while the % of TOTAL INCOME SPENT INCREASES.
An 'ENGEL CURVE' is a graph that shows the relationship between DEMAND for a good (x-axis) and INCOME LEVEL (y-axis).
If the SLOPE of the curve is POSITIVE, (demand rises when income rises) the good is a NORMAL GOOD but if it is NEGATIVE, (demand falls when income rises) the good is an INFERIOR GOOD.
To sum up, it shows how INCOME LEVELS impact whether a good is considered a luxury, a necessity or an inferior good.

-ENGEL CURVE IN ACTION-

--IMPORTANCE TO PRODUCERS [HL ONLY]--

--EXPANSION--

During an EXPANSION of the economy, knowing the YED is important as when incomes rise. Ideally, a PRODUCER/INVESTOR will wish to INVEST in a market for an INCOME ELASTIC good or service as it will be expanding at a faster rate than income. E.g. Bubble tea in Singapore.

--RECESSION--

During a RECESSION, knowing the YED is important as when incomes fall. markets for NORMAL GOODS suffer a loss of sales. especially those for INCOME ELASTIC goods which suffer the most, followed by markets for INCOME INELASTIC goods. While in contrast markets for NEGATIVE INFERIOR GOODS can even experience increases in sales.

--YED & STRUCTURAL CHANGE [HL ONLY]--

PRIMARY + <1

When an economy grows why does the PRIMARY sector GROW SLOWER than INCOME?

Agriculture is the main part of the primary sector, and food is INCOME INELASTIC. As society’s income grows over time, the demand for agricultural output grows more slowly than the growth in income.

MANUFACTURING + >1

When an economy grows why does the MANUFACTURING sector GROW FASTER than INCOME?

MANUFACTURED products (cars, televisions, computers, and so on) have a YED that is usually greater than one (INCOME ELASTIC), so that as society’s income grows, the demand for these products grows faster than income.

SERVICES + >1

When an economy grows why does the TERTIARY sector GROW FASTER than INCOME?

Many services have even higher YEDs than manufactured goods, so the percentage increase in the demand for these is much larger.

--REAL WORLD FOCUS--

--HOW YED CHANGES--

$100: At an initial income of $100, 2 basic hamburgers are consumed per week.
$100-$150: AT VERY LOW INCOMES, hamburgers are considered a ‘LUXURY GOOD’, so when income starts to rise, the % Change in D is greater than the % Change in Y, hence the YED is POSITIVE & GREATER THAN ONE, making hamburgers a ‘NORMAL GOOD’ which is ‘INCOME ELASTIC’.
$150-$250: AS INCOME GROWS, hamburgers are considered a ‘NECESSITY’, because consumption is already close to the maximum required, so the % Change in D is less than the % Change in Y, hence the YED is POSITIVE but LESS THAN ONE, making hamburgers a ‘NORMAL GOOD’ which is ‘INCOME INELASTIC’.
$250-$350: AS INCOME GROWS MORE, hamburgers aren’t luxuries nor necessities as the maximum desired level of consumption has been reached, so the % Change in D is ‘zero’, regardless of the % Change in Y.
$350-$450: AT HIGHER INCOMES consumer now substitute in a higher valued alternatives in the form of a ‘big-mac’ therefore, the % Change in D is NEGATIVE as such basic burgers are now considered ‘INFERIOR GOODS’ with a NEGATIVE YED.

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