Income and cross elasticity of demand
Income elasticity of demand
$$\text{YED} = \frac{\%\ \text{change in quantity demanded}}{\%\ \text{change in income}}$$
- a normal good has positive YED (demand rises with income); luxuries have YED above 1.
- an inferior good has negative YED (demand falls as income rises) — e.g. cheap instant noodles.
Practice
An inferior good has:
For an inferior good, higher income means less demand (people switch to better goods).
Practice
A normal good has positive income elasticity of demand.
Normal goods see demand rise as income rises (positive YED); luxuries exceed 1.
Cross elasticity of demand
$$\text{XED} = \frac{\%\ \text{change in quantity of A}}{\%\ \text{change in price of B}}$$
- substitutes → positive XED (B dearer → buy more A).
- complements → negative XED (B dearer → buy less A and B).
- unrelated goods → about zero.
Practice
For two substitute goods, the cross elasticity of demand (XED) is:
Substitutes have positive XED; complements have negative XED.
You've got it
Key idea
- YED = %ΔQ ÷ %Δincome: normal good +ve, inferior good −ve
- XED = %ΔQ(A) ÷ %ΔP(B): substitutes +ve, complements −ve
- as incomes grow, demand for luxuries (YED > 1) grows fastest