Skip to main content

Income elasticity of demand (YED)


    Income elasticity of demand (YED)

       %DQD/%DY

            Income elasticity of demand (YED): the responsiveness of the quantity demanded of a good to changes in consumer income.
YED allows us to work out which goods are inferior, luxury and normal.

When YED > 1 or <-1, demand is elastic.
When YED is between -1 and 1, demand is inelastic.
When YED < 0, goods/services are inferior. This means as income rises, demand for these goods decreases. (e.g. bus tickets) They vary inversely with income.
When YED < -1, goods are very inferior (e.g. own-brand labels, cheap cuts of meat).
When YED = 0, demand for the good is independent of income.
When YED > 0, goods/services are normal. Demand for these goods vary directly with income, and the state of the economy.
When YED is between 0 and 1, goods/services are necessary. When income increases, demand for these goods go up a proportionally smaller amount (e.g. potatoes)
When YED > 1, goods/services are luxury. The demand for these goods goes up by a larger proportion than any increase in income. (e.g. DVDs) NB: this is a technical term.
Therefore, luxury goods are more volatile, as demand changes dramatically depending on small changes in income.
Inferior goods can also be volatile but are counter-cyclical (demand will increase when incomes fall)
Necessary goods are not very volatile.
Companies that produce luxury or very inferior goods can try to smooth out any volatility by
>  Changing prices
>  Diversifying offerings (e.g. diffusion lines) or focus on sales in other countries
>  Advertising

Terms of trade: relative prices of exports vs imports.
Primary goods tend to be inelastic, as they tend to be necessary goods.
Manufactured goods tend to be elastic, as many are luxury goods.

Therefore, developing countries tend to have declining terms of trade as, as living standards rise, demand for manufactured goods will rise more quickly than demand for primary goods, so the price of their imports will be greater than the price of their exports.
Labels:

Comments

Post a Comment

Popular posts from this blog

Business Growth

Why do businesses grow?  Profit motive Businesses grow to make more profit by increasing revenue. Selling more to more people often means profits increase.  The valuation of a company's share is often influenced by how it is expected to do in the future (ie how much profit it is likely to make). When it is projected to do well, share prices increase, and it is valued more highly on the stock market. This provides incentive for companies to increase profits, doing well on the stock market increases investment and raises more money.  Cost motive - economies of scale When firms are larger, relative costs are smaller. This is because some costs are fixed, so if you are a larger company, producing larger output, the cost per unit will decrease.  e.g. If a T-shirt factory's main cost is the £10,000 to rent to factory each month, and it produces only 1000 shirts a month, each shirt costs £10 to make. But if it scales up and produces 100,000 shirts a month, ...
Post a Comment
Read more

3.4.1 Efficiency

Efficiency   Allocative efficiency  Output at which the marginal utility, or benefit, of a good to a consumer is the same as equal to the marginal cost of producing it.  This is seen on demand/supply curves, where D = S, output is produced as demand = marginal utility and supply = the sum of firms' marginal costs in an industry. On an individual scale, it is where:  AR = MC  Output is where the demand curve cuts the MC curve.   NB: technically occurs where MSB = MSC (if you consider externalities)  Occurs in perfect competition.  Eval - PC markets achieve allocative efficiency where there are no externalities.  LR equilibrium is where P = MPC, so if MSC > MPC, then there is an allocative inefficiency which leads to overproduction and consumption.  Productive efficiency  Output at which a good is produced at the  lowest possible average cost for a firm. This oc...
Post a Comment
Read more

3.3.4 Normal profits, supernormal profits and losses

Normal profits, supernormal profits and losses  Profit maximisation  Occurs at: MC = MR  where MC cuts MR from below (as where it cuts from above is point of profit minimisation)  This is because past this point MR < MC , and each additional good is costing the firm more than it is making. Before that point MR > MC so the firm can increase profit by producing more.  NB - point of prof max can be found using TC and TR:  Normal and supernormal profit and losses Normal profit is profit that covers the opportunity cost of capital and is just sufficient to keep the firm in the market.  Supernormal/economic profit are profits that exceed normal profits.  When AC lies below AR at the point of output, the difference between AR and AC is the supernormal profit on that unit output. The overall supernormal profit is the difference times the quantity sold (Q2 in the above)....
Post a Comment
Read more