Now let's talk about another elasticity of demand, the income elasticity of demand. So remember that income was one of the things that could shift our demand curve, right? When we studied that in supply and demand, when we were shifting our demand curve, consumer income could affect the demand for goods right and that's when we talked about normal goods and inferior goods right, so an increase similar discussion where the here is a similar discussion where the income elasticity of demand is going to help us identify goods as normal goods or inferior goods, right? So let's go ahead and check out the equation. We've got income elasticity of demand, right? It's going to answer the question how does quantity demanded respond to a change in consumer income, right? When we were doing price elasticity of demand, it was the same thing except how does quantity demanded respond to a change in price, right? So notice the only thing that's changing with our formula here is first the name, right? Now we're talking about income elasticity of demand and now instead of price in the denominator, we've got income in the denominator and you should be able to notice that we've got this pattern going that whatever the name of it, income elasticity, income in the denominator. Quantity is always going to be in the numerator for all of our elasticities. Most of them are going to be quantity demanded, but when we're talking about quantity supplied, we'll have quantity supplied in the numerator. But here we go, income and income, right. Easy peasy. So let's go ahead and use our midpoint method, right. We're still going to use that same method that we already know of, except we're just going to update it that it's going to be dealing with income instead of price, right? So our second variable instead of it being price, now it's going to be income, but our calculations are going to stay stay basically the same except for this one added step here where we're going to notice that positive and negative numbers do matter in this case. This is how we're going to make our analysis is when we have positive or negative numbers, they're going to help us identify normal and inferior goods. So although all our steps are the same, we're going to have an added step 6 where we're going to analyze the direction of the movement of quantity and the direction of the movement of income to get our positives and negatives. Okay, so let's go ahead and do an example where we're going to use our same method and then we'll have that added step 6. Notice I've got that step 6 here, which we're going to do after we've gotten our answer. So let's go ahead and use these steps in this example. At a price of $75 per serving of caviar, the quantity demanded is $9,000 Although price did not change, consumer income increased from $9.50 per week to $10.50 per week causing the quantity demanded to increase to $11,000 What is the income elasticity for demand of caviar? So let's go ahead and start by marking off our quantities and our incomes, right. We've got quantity demanded of $9,000, one to $11,000 and our income, right, not price this time. We're talking about income elasticity, $9.50 to $10.50, but check it out. At the beginning of problem, they did give us a price. They said price was $75, but they also said price did not change, which is good for us, right, because we want to hold everything constant. This goes back to that ceteris paribus, the only thing we want to change is the income and see how that affects demand, right? So the idea here is price did not change, price doesn't even come up in our formula, right. Up here percentage change in quantity demanded divided by percentage change in income, we don't talk about price at all there, so price is irrelevant. Let's go ahead and do our steps. Alright so step 1 is where we do our subtraction. So let me make 2 columns. We've got our quantity demanded and notice this is one of our small changes is that our second column is going to be income, but notice how similar the steps are. Let's go with step 1. I'm going to move this over to save some space. Quantity demanded, and right here income. So step 1 just like before, we're gonna subtract the 2 quantities and it still doesn't matter which one you do first just as long as we include that step 6 where we're going to analyze the positives and the negatives. So for now, I just like to keep the math simple and just keep all these positive numbers while I do this. So income $10.50 $9.50 is going to give us a change of a 100. Alright. Step 2, just like before, we're gonna sum them. So now we've got 11,000 +9,000 equals 20,000 and the same thing for income. Let's sum the incomes. 1050 plus 950 is going to give us 2,000. Step 3 is where we divide our answer from step 2 by 2. So step 3 right here, we are going to have $20,000 divided by 2 which is just 10,000 how about income? Income, we're gonna have 2,000 divided by 2 which is 1,000. Step 4, just like before is hey, that rhymed. Step 4, that's where we just divide our answer from step 1 and our answer of step 3. So we're gonna get 2,000 divided by 10,000 and that is going to give us 0.2, right. 0.2 that is our percent change in quantity demanded right? Just like before, our answer to step 4 is the percent change in quantity demanded and on the other side, 100 divided by a1000, right, answer from step 1 divided by answer from step 3 is 0.1 and that is our percentage change, not in price this time, our percentage change in income, right? Which is the denominator of our income elasticity. So let's go ahead and do step 5 here. So I'm going to put step 5 because we do have a step 6 now, and step 5 is where we're going to calculate our income elasticity, which is going to be the 0.2 divided by the 0.1. Right? So 0.2 divided by 0.1, that is equal to the to 2. Our answer here is 2, but let me get out of the way, but we have to see is it a positive 2 or a negative 2? We're not sure yet. We need to go back to the problem and analyze whether the quantity change was positive or negative and whether the income change was positive or negative. Let's start with quantity. Quantity demanded started at $9,000 then income changed and quantity demanded increased to $11,000 so we saw an increase in quantity demanded, that was a positive change, so that is going to be a positive quantity demanded, so it's going to be a positive in the numerator. Now let's look at the income. Income was $9.50 and it increased to $10.50 so easy enough here, we got a positive in the denominator as well, so we are going to have a positive 2. Okay, so the same thing could have happened if we had a decrease in quantity demanded, right? Let me just erase these and pretend we had a decrease in quantity demanded from 11,000 to 9,000 and a decrease in income from $10.50 to $9.50 we would have gotten the same answer. We would have gotten a negative on the top, a negative on the bottom, problem and see whether quantity increased and whether income the problem and see whether quantity increased and whether income increased, right? So an increase is going to be a positive number and a decrease is a negative number. So there we go, we have gotten our answer to our income elasticity is 2, but how do we analyze that right? This is how we're going to analyze our answers. So when we get a positive number that's greater than 1, this we call income elastic and this is a normal good that's a luxury. This is a good that when our income goes up we buy even more of it than our increase in income, our quantity increases more than our increase in income, right? And this is because now we have more money to spend, we spend it on luxury items. Compared to this one where we have a positive answer but it's less than 1, so we get some sort of decimal like 0.5 or 0.7 where it's still positive, it's still a normal good because we made more money and we spent more on it, right? Remember from our demand shifts, if consumer income increases we spend more on normal goods. So we would expect to get a positive income elasticity of demand here, but this is in this case a necessity. It's stuff that we were already buying before, good where now we have more money so we have money to play around with this luxury stuff. And when we get a negative answer that's when we're talking about an inferior good, right? Cause that would be where we have an increase in income and a decrease in quantity demanded or the opposite, a decrease in income and an increase in quantity demanded. So that's the case of inferior goods just like we discussed in supply and demand, the shifts in demand. Cool, so that's how we're going to analyze here. So in this situation, we got a positive number that was greater than 1. It's income elastic, we're gonna say it's a normal good, and that it's a luxury good. Alright, so we were able to get that just from our income elasticity of demand that we calculated. Cool, let's go ahead and do some practice problems with income elasticity of demand.
Income Elasticity of Demand: Study with Video Lessons, Practice Problems & Examples
Created using AIIncome elasticity of demand measures how quantity demanded responds to changes in consumer income. The formula is , where ΔQ is the change in quantity demanded and ΔI is the change in income. A positive elasticity greater than 1 indicates a luxury normal good, while a positive elasticity less than 1 indicates a necessity. A negative elasticity signifies an inferior good, where demand decreases as income increases.
Income Elasticity of Demand
Video transcript
Johnny Clutch just got a raise from $900 per week to $1100 per week. As a result, he decreases the amount of ramen noodles he buys from seven cartons a week to one carton a week. For Johnny, ramen noodles are:
Johnny Clutch just got a raise from $950 per week to $1,050 per week. As a result, he increases the number of concerts he attends by five percent. His demand for concerts is:
A twelve percent increase in consumer income has caused the quantity of orange juice demanded to increase from 24,000 to 26,000. The income elasticity of demand for orange juice is:
Here’s what students ask on this topic:
What is the formula for calculating income elasticity of demand?
The formula for calculating income elasticity of demand (YED) is:
Here, represents the percentage change in quantity demanded, and represents the percentage change in income. This formula helps determine how sensitive the demand for a good is to changes in consumer income.
Created using AIHow do you interpret the income elasticity of demand?
Interpreting the income elasticity of demand (YED) involves understanding the sign and magnitude of the calculated value:
- Positive YED > 1: Indicates a luxury normal good. Demand increases more than proportionally as income rises.
- Positive YED < 1: Indicates a necessity normal good. Demand increases less than proportionally as income rises.
- Negative YED: Indicates an inferior good. Demand decreases as income rises.
This interpretation helps categorize goods based on how consumer demand responds to income changes.
Created using AIWhat is the difference between normal goods and inferior goods in terms of income elasticity of demand?
Normal goods and inferior goods differ in their income elasticity of demand (YED):
- Normal Goods: These have a positive YED. If YED > 1, they are luxury goods, meaning demand increases more than proportionally with income. If YED < 1, they are necessities, meaning demand increases less than proportionally with income.
- Inferior Goods: These have a negative YED. Demand for these goods decreases as income increases, indicating that consumers buy less of these goods as they become wealthier.
This distinction helps in understanding consumer behavior and market dynamics.
Created using AIHow do you calculate the percentage change in quantity demanded and income for income elasticity of demand?
To calculate the percentage change in quantity demanded and income for income elasticity of demand (YED), use the midpoint method:
Percentage Change in Quantity Demanded:
Percentage Change in Income:
Here, and represent the changes in quantity demanded and income, respectively. and are the initial and final quantities demanded, while and are the initial and final incomes.
Created using AIWhat are some examples of goods with high income elasticity of demand?
Goods with high income elasticity of demand (YED > 1) are typically luxury items. Examples include:
- Luxury Cars: As income increases, consumers are more likely to purchase high-end vehicles.
- Designer Clothing: Higher income leads to increased spending on premium fashion brands.
- Travel and Tourism: With more disposable income, people tend to spend more on vacations and travel experiences.
- High-End Electronics: Items like the latest smartphones, high-definition TVs, and advanced gadgets see increased demand with rising incomes.
These goods are considered luxuries because their demand grows more than proportionally with income increases.
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