INCOME ELASTICITY OF DEMAND
This type of elasticity (YED) looks at the relationship between income and changes and demand for a good, ie if incomes change by how much will the demand curve for a good move.
The formula for YED is % change in D/%change in Y
If income rise by 10% and demand goes up by 15%, YED is +1.5 (income elastic)
If Income rise by 10% and demand goes down by 6%, YED is -0.6 (income inelastic)
The sign of the coefficient is important. In the top example we are looking at normal goods, because the coefficient is positive, ie income and demand move in the same direction. The top example suggests the good is an inferior good (negative sign)
Influences on YED
Is the good a necessity or luxury: necessities tend to have a low YED because as income rise, the increase in demand will be relatively low (eg bus travel). As incomes rise, the demand for luxuries rises quite fast (eg foreign holidays)
The satisfaction of a desire for a good: the sooner consumers are satisfied as they consume a good as income rises, the more inelastic will YED become.
Application of YED
The major application of YED is the relationship between the trade cycle and the output of goods indifferent industries.
Those industries whose demand is income elastic will see raising sales as the economy expands (eg housing and expensive holidays), whilst those industries selling goods with low YED's will see only small increases in sales (eg washing up liquid). However when the economy contracts, the opposite will happen. The income elastic industries will see sales and profits fall sharply, whilst the income inelastic sector will see sales and profits fall slower. Those industries selling inferior goods might do well in a recession (eg second shops).