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					Income Elasticity of

     DP Economics
              Key Issues
 The  meaning of income elasticity of
 Measuring income elasticity
 Normal goods
 Luxury goods
 Inferior Goods
 Income elasticity of demand and the
  economic cycle
    Income Elasticity of Demand
   Income elasticity of demand (YED) measures the
    responsiveness of quantity demanded to changes
    in real income.
   YED = %Δ demand / %Δ in income
   Example:
       A rise in consumer real income of 7% leads to
        an 9.5% rise in demand for pizza deliveries.
       The income elasticity of demand:
                          = 9.5/ 7 = +1.36
     Effect         Income elasticity   Classification of
                       coefficient           good

A proportionately          >1            Luxury good
larger change in
   the quantity
A proportionately          <1               Normal
smaller change in
   the quantity
A negative change          <0            Inferior good
  in the quantity
               Inferior Goods
 Inferior goods have a negative income
  elasticity of demand. Demand falls as
  income rises
 For   example:
     A 12% rise in incomes leads to a 3%
      decrease in the demand for bus travel
     The income elasticity of demand = -3/+12
     Yed = -0.25
    Different Types of Goods and
        their Income Elasticity
Luxury                Normal Necessity Inferior Good
Air travel            Fresh vegetables   Frozen vegetables

Fine wines            Instant coffee     Cheep Cigarettes
Luxury chocolates     Natural cheese     Processed cheese
Private education     Fruit juice        Margarine
Private health care   Spending on        Tinned meat
Antique furniture     Shampoo /          Value “own-brand”
                      toothpaste /       bread
Designer clothes      Rail travel        Bus travel
Income Elasticity of Demand for
   Total consumption
      USA +0.79

      Germany +0.39

      United Kingdom +0.44

      France +0.60

      Japan +0.1

      Switzerland +1.06

   Reference: Henri Jason Trends in cocoa and chocolate
    consumption with particular reference to developments in
    the major markets. Malaysian International Cocoa
    Conference, Kuala Lumpur, 20-21 October 1994 (ICCO,
    ED(MEM) 686)
        Income Elasticity and the
        Demand for Airline Travel
   Demand for air travel has a positive income elasticity of
   The industry is cyclical
       During an upturn, demand rises for business and
        leisure travel
       During a recession, the demand tails away
   In the long run, there is a positive relationship between
    real GDP per capita and the demand for air travel
   Income elasticity will vary according to the type of air travel
       E.g. difference between low-cost “no-frills” and higher
        priced scheduled services on low-haul flights
                               Income Per Capita and Airline
                                    Travel by Country


                                                                                                                              Hong Kong China
                                                                                             New Zealand                                                      US
                                                                                                                 Australia                Sw itzerland

                                                                                                                     Netherlands Canada
ASK (000) per capita

                                                     Ecuador                                            Israel            UK
                                                                                                                                             Norw ay
                                                                                                   Spain                        France        Japan
                                                              Malaysia                                                Finland
                                                                       Saudi Arabia Greece               IrelandSw eden Germany        Belgium
                                                    Thailand                                    Portugal                         Austria
                       1000         Dominican Rep               Panama                      Korea Rep
                                                                 S. Africa                                              Italy
                                                 Lebanon                              Chile
                                                Costa Rica             Mexico
                                             Peru               Brazil    Venezuela
                                   Philippines          Tunisia  Hungary
                            Sri Lanka                           Colombia       Argentina
                              Kenya Zimbabw e Bulgaria Turkey                    Czech Rep
                                                        Croatia          Uruguay
                            Cote D'Ivoire                                           Slovenia
                                             Syria Lithuania
                            Pakistan Paraguay Romania Poland
                               Vietnam China Algeria Iran
                                       Cameroon     Belarus
                                 India  Ukraine

                               0                 5000                  10000                 15000                 20000                 25000                     30000   35000
                                                                                             GNP per capita ($ PPP)
Significance of Income Elasticity
           of Demand
 High   Income Elasticity
     Demand is sensitive to changes in real
     Demand is therefore cyclical – in an economic
      expansion, demand will grow strongly. In a
      recession demand may fall
     Can be difficult for businesses to accurately
      forecast demand and make capital investment
Significance of Income Elasticity
           of Demand
 Low   Income Elasticity
     Demand is more stable during fluctuations in
      the economic cycle than high YED
     Over time, the share of consumer spending
      on inferior goods and normal necessities
      tends to decline
     Long run – businesses need to invest in /
      focus on products with a higher income
      elasticity of demand if they want to increase
      total profits

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