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IB DP Economics — Unit 2: Microeconomics | SL | 2.5 Elasticities of Demand
📋 What You Will Learn
- Define income elasticity of demand (YED) and state the formula
- Identify and distinguish between normal goods, inferior goods, and luxury goods using YED values
- Explain the significance of YED for firms making production and investment decisions
- Analyse how YED affects industries differently across the business cycle
- Apply YED to real-world economic scenarios involving income changes and demand shifts
- Evaluate the usefulness and limitations of YED as a tool for business and government decision-making
🔍 Guiding Question How does the relationship between consumer income and demand for different goods shape the strategies of firms and the priorities of governments — and what does this reveal about the nature of economic development?
🌍 Why This Matters When India's GDP per capita grew by 7.2% in 2023, demand for smartphones surged while demand for basic cereals barely moved. In the same year, as UK real incomes fell due to inflation, discount supermarkets like Aldi and Lidl reported record market share gains — while premium restaurant chains saw bookings collapse. The same income change; completely opposite effects on different industries. The difference is income elasticity of demand.
What Is Income Elasticity of Demand?
When consumers earn more money, they do not simply buy more of everything. Some goods become much more attractive; others become less appealing; and some are barely affected at all. YED captures this relationship precisely — it tells us not just whether demand changes with income, but by how much and in which direction.
📖 Definition — Income Elasticity of Demand (YED) Income elasticity of demand (YED) measures the responsiveness of quantity demanded of a good to a change in consumer income, ceteris paribus.
YED Formula
\[ \text{YED} = \frac{\%\Delta Q_d}{\%\Delta Y} \] Where \( \%\Delta Q_d \) is the percentage change in quantity demanded and \( \%\Delta Y \) is the percentage change in consumer income.
Unlike PED, YED can be positive or negative — and the sign is economically meaningful. A positive YED means demand rises as income rises (a normal good). A negative YED means demand falls as income rises (an inferior good). The magnitude tells us how sensitive demand is to income changes.
Interpreting YED Values — The Classification of Goods
The sign and magnitude of YED together determine how a good is classified. This classification is not merely academic — it has direct implications for how firms plan production, how investors allocate capital, and how governments forecast tax revenues across the business cycle.
Positive YED — Normal Goods
📖 Definition — Normal Good A normal good is one for which demand increases as consumer income rises, ceteris paribus. YED is positive (YED > 0).
- Income-inelastic normal goods (0 < YED < 1): demand rises with income, but less than proportionately — these are necessities (e.g. bread, basic clothing, electricity, bus travel)
- Income-elastic normal goods (YED > 1): demand rises more than proportionately with income — these are luxury goods (e.g. foreign holidays, sports cars, fine dining, designer clothing)
📖 Definition — Luxury Good A luxury good is a normal good for which demand rises more than proportionately as income rises, giving a YED greater than 1. As incomes