Income elasticity of Demand (YED) Four types of good can be identified using YED:

Income elasticity of demand (YED) measures the responsiveness of the A normal good is one where the quantity demanded increases as income
quantity demanded for a good to a change in income. It measures how increases. Most products are like this. In emerging economies
the quantity demanded is affected by a change in a consumer's income. especially, the demand for cars increases as incomes increase as a result
of economic growth. For normal goods, the YED is positive and
expected to be between 0 and 1.
An inferior good is one where the quantity demanded decreases as
income increases or increases as income falls. When income rises,
YED Classification of goods consumers use their increased incomes to buy better quality goods to
replace inferior quality goods. Typical examples of inferior goods are
<0 Inferior good – as income rises the demand for the
(negative) product will fall poor quality biscuit and packet noodles. The YED is negative.
A necessity good is a type of normal good for which the quantity
0 to +1 Normal good – income inelastic demand demanded is unlikely to change when income changes. Basic foodstuffs
such as rice, flour and pulses that are regularly consumed are typical.
+1 to ∞ Normal good – income elastic demand The YED is positive but is likely to be close to zero. A low value for the
YED indicates that quantity purchased does not change by much when
income changes drastically..
YED greater than 1, implies the good has elastic demand with respect
A superior or luxury good has a positive YED that is greater than 1
to changes in income. The percentage change in quantity demanded will
and is a normal good where the quantity demanded is responsive to
be greater than the percentage change in income.
changes in income. The higher the size of the YED, the greater the
YED less than 1, implies the good has inelastic demand with respect to change in quantity demanded. Examples of superior goods are designer
changes in income. The percentage change in quantity demanded will clothes and jewellery or a round of golf.
be less than the percentage change in income.
The above classification of goods in relation to income depends on the
The classification of goods in relation to income level of income of consumers or households. A necessity good for one
family could be a normal good for a better-off family. For example, rice
YED is used to classify goods in relation to changes in the incomes of
or flour are likely to be necessity goods for low-income families yet are
consumers. This classification is based on the size (in numerical terms)
more likely to be inferior goods for those with higher incomes.
and the sign (positive or negative) of the YED.
Importance of income elasticity of demand
1. Knowledge of the essence of goods:
Income elasticity is a term that helps to differentiate between important
and non-essential goods. High-income elasticity commodities are
luxuries. As a person becomes affluent, he spends higher proportions of 3. Firms can diversify
his income on goods such as jewelry, air conditioners, mobile phones.
When revenue increases, the proportion of revenue spent on matches, This knowledge will also help producers to diversify and offer a range
soaps, newspapers, salt, shoes falls. However, a good that is a necessity of products so that whatever the point in the business cycle, sales can be
at a specific level of income may become luxury at another level. made. Hence, typically, a car producer will offer budget cars as well as
mid-range and expensive cars, and in this way it can have some
2. Governments can plan confidence that, whatever the state of the macro-economy, it can still
Similarly, government agencies can use data on income elasticities to sell its products.
inform how they plan to allocate their budgets. In the growth phase of Another case may be a car retailers interested to know how the quantity
GDP individuals are more likely to go on holidays and purchase demanded for new cars in a specific area is changing. In a case like this,
electronic products. we can look at consumer's income. If the area is growing, and incomes
This means that more public resources may need to be allocated towards are increasing, we can assume that more new cars will be demanded. On
transport infrastructure, and to waste disposal as households acquire the other hand, if incomes are decreasing, we can anticipate that more
more packaging associated with purchasing electronic goods. people will buy secondhand automobiles or take public transportation.

Changes in real incomes across the economy will reflect changes in the
business (or economic) cycle.