For example, if your income increased by 5% and your demand for mobile phones increased 20% then the YED of mobile phones = 20/5 = 4.0
Unlike price elasticity, whether the result of the calculation is a positive or negative number is very significant.
If an increase in income leads to an increase in demand (a positive + result of the calculation) this would be a 'normal' product.
If the value of income elasticity is negative - where an increase in income leads to a fall in demand - this would be known as an 'inferior' product.
Factors influencing income elasticity of demand:
Whether the product is a luxury, necessity or inferior product.
Expectations of changes in income such as job loss or promotion, recession or economic growth.
What does this suggest about income elasticity of demand for Laura Ashley?
Products can be Income Elastic or Income Inelastic (although both must be normal products with a positive + result from the calculation.) The factors influencing income elasticity of demand:
Necessities such as electricity will be income inelastic. (With a result from the calculation being in the range 0 - 1.0)
Luxuries tend to be income elastic. (With a result from the calculation being in the range 1.0+)
Definition of Inferior Good
This occurs when an increase in income leads to a fall in demand.
Other examples of inferior goods: clothes from charity shops, cheap bread.
Definition of a Normal good
This occurs when an increase in income leads to an increase in demand for the good, therefore YED is greater than 0.
Definition of a Luxury good:
When an increase in demand causes a bigger percentage increase in demand, therefore YED equals greater than 1.
For example, if your spending on Game Apps increases 25% after a 10% increase in income – this is luxury good; the YED = 2.5
Luxury goods will be income elastic with a numerical result greater than one.
Income inelastic. This means an increase in income leads to a smaller percentage increase in demand.
Using knowledge of income elasticity of demand:
Firms will make use of income elasticity of demand by producing more luxury goods during periods of economic growth.
In a recession with falling incomes, supermarkets might be advised to promote more ‘value’ inferior goods.
