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Income Elasticity of Demand by fionan

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									Income Elasticity of
          Demand
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Aims:
   To understanding the concept of YeD

   To have written and numerate understanding of elasticity
    figures (elastic & inelastic)

   To understand the implications for revenue and profit
    (and therefore decision-making);
Formula
   Income elasticity of demand (Yed) measures the
    relationship between a change in quantity demanded
    and a change in real income



   Yed = % change in demand
              % change in income
   There are 3 different
types of Income Elastic
                 Goods
Income Elasticity of Demand:
   Normal Good – demand rises as income
    rises and vice versa

   Inferior Good – demand falls as income
    rises and vice versa
Look out for the sign…!
   A positive sign (+) denotes a normal good

   A negative sign (-) denotes an inferior good
The details you need to know

   Normal goods have a                Luxuries have an income
    positive income elasticity of       elasticity of demand > +1
    demand

                                       So the demand rises more
   As consumers‟ income rises,         than proportionate to a
    so more is demanded at each         change in income
    price level
                                       Inferior goods have a
                                        negative income elasticity
   Normal goods have an                of demand.
    income elasticity of demand
    of between 0 and +1                Demand falls as income
                                        rises
The detailed
 knowledge
+      Positive Income Elasticity

   A rise in income will cause a rise in demand

   A fall in income will cause a fall in demand

   Coffee example…. A 10% increase in income
    will result in a 2.3% increase in demand for
    coffee.
   What‟s the YeD?
   What will this look like on a D & S diagram?
Positive Income Elastic
Demand Diagram
   Note the axes are DIFFERENT!
Elastic or Inelastic + YeD
   Elastic goods – are      Inelastic goods – are
    seen as LUXURIES OR       seen as NORMAL or
    SUPERIOR!                 NECESSITIES.
-      Negative Income Elasticity

   An increase in income will result in a
    decrease in demand.

   A decrease in income will result in a rise in
    demand.



   ALSO known as INFERIOR GOODS
Negative Income Elasticity
   Potatoes are seen as a inferior product

   Potatoes have a YeD of -0.48

   So a 10% rise in incomes will result in????

   What would this look like on a D&S diagram?
Negative Income Elasticity
Diagram = Inferior
   Note the different axes labels
Zero Income Elasticity
   This occurs when a
    change in income
    has NO effect on the
    demand for goods.

   A rise of 5% income
    in a rich country will
    leave the Demand
    for toothpaste
    unchanged!
So to summarise
Look for the signs!

NORMAL      GOODS              LUXURY GOODS



+   BETWEEN 0 & 1
    +0.5 +0.9 + 0.1               +     GREATER THAN 1
                                        +2 +5 +27




               INFERIOR      GOODS


                 -    CAN BE A DECIMAL OR A VALUE
                      GREATER THAN 1
For example:
   Yed = - 0.6:                        Yed = + 1.6:
    Good is an inferior good but         Good is a normal good
    inelastic                            and elastic
    a rise in income of 10% would      a rise in incomes of 10%
    lead to demand falling by 6%         would lead to demand rising
                                         by 16%
   Yed = + 0.4:
    Good is a normal good but           Yed = - 2.1:
    inelastic                            Good is an inferior good
   a rise in incomes of 10% would       and elastic
    lead to demand rising by 4%         a rise in incomes of 10%
                                         would lead to a fall in
                                         demand of 21%
So what’s a Normal, a
Luxury and an Inferior
               good?

                          In groups of 3‟s …
 You will each be „given‟ a set of goods and
     you have to decide whether each is a
                                       normal,
                                     luxury or
                           an inferior good…
You decide….
   Bus travel                    Margarine
   Cigarettes                    Stilton
   Designer clothes              Private education
   Fine wines                    Private health care
   Fresh vegetables
                                  Stringy cheese
   Frozen vegetables
                                  Rail travel
   Fruit juice
   Instant coffee                Shampoo
   International air travel      Tinned meat
   Luxury chocolates             Value “own-brand” bread
      So which would have negative
                                 value
     So which would have aa++value –
    So which would have a
           GREATER AND 1?
          BETWEEN 0THAN1?
       value? i.e. an inferior good?
           i.e. NORMAL good?
         i.e. a a LUXURY good?
   Bus travel                    Margarine
   Cigarettes                    Natural cheese
   Designer clothes              Private education
   Fine wines                    Private health care
   Fresh vegetables              Processed cheese
   Frozen vegetables             Rail travel
   Fruit juice                   Shampoo
   Instant coffee                Tinned meat
   International air travel      Value “own-brand” bread
   Luxury chocolates
A Diagram for you…
Relationship between Income
and Quantity Demanded
 Quantity




                Zero
                income
                elastici
                ty              Positive income elasticity        Negative income elasticity
                                                                  [inferior good]




            0              y1                                y2
                                                Income
Income Elasticity of Demand for
Chocolate
                                                    Which country has
                                                     the sweeter tooth
Total consumption                                    when it comes to
                                                   income elasticity for
 USA 0.79                                             chocolate??
 Germany 0.39

 United Kingdom 0.44

 France 0.60

 Japan 0.08

 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 demand
   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
Examples of YeD                        YeD mantra…
                                        + = normal
                                        - = inferior!
For example:


   Yed = - 0.6: Good is an inferior good but inelastic – a rise
    in income of 10% would lead to demand falling by 6%


   Yed = + 0.4: Good is a normal good but inelastic – a rise
    in incomes of 10% would lead to demand rising by 4%


   Yed = + 1.6: Good is a normal good and elastic – a rise in
    incomes of 10% would lead to demand rising by 16%
                                      Your handout has different
                                      figures…annotate these to
   Yed = - 2.1: Good is an inferiorgood and elastic – a rise
                                             your handout          in
    incomes of 10% would lead to a fall in demand of 21%
                         Income Per Capita and Airline
               100000
                         Travel by Country
                                                                                                                               Singapore

                                                                                                             Hong Kong China
                       10000
                                                                                New Zealand                                         US
                                                                                                 Australia           Sw itzerland
ASK (000) per capita




                                                                                                    Netherlands
                                                                                                             Canada
                                                                                        Israel                     Denmark
                                                   Ecuador                                             UK
                                                                                                                        Norw ay
                                                                                     Spain                   France     Japan
                                                        Malaysia                                     Finland
                                                               Saudi Arabia
                                                                         Greece            Ireland eden           Belgium
                                               Thailand                            Portugal      Sw    GermanyAustria
                       1000       Dominican Rep          Panama                 Korea Rep
                                                           S. Africa                                 Italy
                                              Lebanon                      Chile
                                             Costa Rica         Mexico
                                          Peru           Brazil Venezuela
                                  Philippines      TunisiaHungary Argentina
                            Sri Lanka                     Colombia                                                         Why do you think
                             Kenya Zimbabw e   Bulgaria Turkey         Czech Rep
                                                                 Uruguay                                                     New Zealand,
                            Cote D'IvoireSyria Croatia                    Slovenia
                                               Lithuania                                                                 Australia, Hong Kong
                            PakistanParaguay Romania Poland
                        100                                                                                              and Singapore are
                               VietnamChinaAlgeria Iran                                                                 above the trend line?
                                       Cameroon Belarus
                                 India Ukraine
                                     Nigeria
                                   Bangladesh


                         10
                               0            5000             10000            15000               20000            25000            30000       35000
                                                                            GNP per capita ($ PPP)
Airlines – a Highly Cyclical
Industry                 What does this
                           mean?
 Real GDP growth                                                                                    Global air traffic
  % year on year                                                                                    % year on year

      8                                                                                                                  16
                                                            World real GDP growth (% vly)
                                                            World scheduled airline RPKs (% vly)                         14
      7
                                                                                                                         12
      6
                                                                                                                         10
      5
                                                                                                                         8

      4                                                                                                                  6

                                                                                                                         4
      3
                                                                                                                         2
      2
                                                                                                                         0
      1
                                                                                                                         -2

      0                                                                                                                  -4
       1971    1973   1975   1977   1979   1981   1983   1985   1987   1989   1991   1993   1995   1997    1999      2001
        Significance of Income
        Elasticity of Demand

   High Income Elasticity
       Demand is sensitive to changes in real incomes
       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 decisions
    Significance of Income
    Elasticity of Demand
   Low Income Elasticity
       Demand is more stable during fluctuations in the
        economic cycle
       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
     Practice time….
  This is NOT exam practice!
The exam paper will NOT look
                     like this!
Income elasticity of demands
in a recession
   Define YeD               Product       YeD

                             Luxury choc   2.4
   What is the formula?
                             Whisky        4.1
   What type of YeD
    would you expect a       Digestive     0.6
    luxury good should       Biscuits
    have?                    Apples        0.2

   Identify the different   Own brand     -0.4
    types of YeD in the      baked beans
    table…
Income elasticity of demands
in a recession
   Estimate the effect a     Product       YeD
    5% fall in income would
    have on each product.     Luxury choc   2.4

                              Whisky        4.1
   Estimate the effect a
    15% increase in income    Digestive     0.6
    would have on each        Biscuits
    product.                  Apples        0.2

                              Own brand     -0.4
                              baked beans
Homework

RED   sheet

Complete   Questions

								
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