Use the sign to identify the income-demand relationship.
Income elasticity of demand (YED) is the percentage change in demand for a good divided by the percentage change in income, other things equal, including its own price. Positive YED indicates a normal good; negative YED indicates an inferior good for those buyers over the specified range. Among normal goods, 0 < YED < 1 is income-inelastic, often termed a necessity, while YED > 1 is income-elastic, often termed a luxury. YED = 1 means proportional demand growth, and zero means no demand response in the stated comparison. These classifications describe behaviour, not moral worth, quality or a permanent property of the product.
- Formula
- Income elasticity of demand (YED) = percentage demand change / percentage income change. Hold the good's own price and other influences fixed.
- Sign
- Positive YED means a normal good: demand rises with income. Negative YED means an inferior good: demand falls as income rises, for the stated buyers and range.
- Positive magnitudes
- For positive YED, between 0 and 1 means demand grows by a smaller percentage than income; above 1 means a larger percentage; exactly 1 means equal percentages.
Classify before applying
Normal necessities
A positive YED below 1 means demand grows less than income proportionately; the necessity label does not imply no demand response.
Normal luxuries
YED above 1 means demand grows more than proportionately with income; high price alone does not establish the classification.
Inferior goods
Negative YED describes demand decreasing as income rises, other things equal. It is not a measure of defects or quality.
Zero and one
Zero means no income response over the stated comparison. One means proportional demand growth; do not force it into a strict below-one or above-one category.
Context
Income levels, tastes and time can change classifications. A demand estimate at a held own price is not automatically final equilibrium sales.
| YED | Classification | Income rises, own price fixed |
|---|---|---|
| Negative | Inferior | Demand falls |
| 0 | No measured income response | Demand unchanged in the stated comparison |
| Between 0 and 1 | Normal, income-inelastic | Demand rises less than proportionately |
| 1 | Normal, proportional response | Demand rises proportionately |
| Above 1 | Normal, income-elastic | Demand rises more than proportionately |
Worked example: Income grows but demand for one product falls
A study holds own price and other demand determinants constant. For a specified consumer group, income rises by 8%, while demand for a particular ready-made meal falls by 4%. Use the supplied percentage changes.
- YED = -4%/8% = -0.5. The negative sign classifies the meal as inferior for this group over this income range.
- The magnitude 0.5 means the proportional demand response is half the income change, in the opposite direction. It does not turn the good into a normal necessity.
- The result need not hold for another group or income range. Buyers might switch towards meals they prefer when their incomes rise.
- The 4% demand fall is measured at a given own price. The eventual equilibrium quantity change also depends on market supply and price adjustment.
Watch out for this
A YED of -0.5 describes a necessity because its magnitude is below one.
Determine normal versus inferior from the sign first. The usual necessity category has positive YED between zero and one.
Check your understanding
Income rises by 5% and demand rises by 12% at unchanged own price, other things equal. What follows?
- YED = 2.4: a normal, income-elastic good over this comparison.
- YED = -2.4: an inferior good.
- Final market sales must rise by exactly 12% whatever happens to supply.