💵 Income Elasticity of Demand (YED)
Definition: YED = % change in quantity demanded ÷ % change in income. It measures how demand responds to income changes.
The sign tells you the type of good
- YED > 0 (positive) → Normal good (demand rises with income)
- YED > 1 → Luxury (demand rises MORE than income — e.g. designer clothes)
- 0 < YED < 1 → Necessity (demand rises LESS than income — e.g. bread)
- YED < 0 (negative) → Inferior good (demand FALLS with income — e.g. instant noodles)
The sign matters for YED (unlike PED). A positive YED = normal good. A negative YED = inferior good. Luxuries have a high positive YED (>1). Necessities have a low positive YED (0-1).
🔗 Cross-Price Elasticity of Demand (XED)
Definition: XED = % change in quantity demanded of Good A ÷ % change in price of Good B. It measures the relationship between two goods.
The sign tells you the relationship
- XED > 0 (positive) → Substitutes (price of B up → demand for A up — consumers switch)
- XED < 0 (negative) → Complements (price of B up → demand for A down — used together)
- XED ≈ 0 → Unrelated goods (no meaningful relationship)
The size of the XED tells you how CLOSELY related the goods are. A high positive XED means very close substitutes (e.g. Coke and Pepsi). A small positive XED means weak substitutes.
If the price of PlayStation rises by 10% and demand for Xbox rises by 15%, XED = +15%/10% = +1.5. This is positive, so they are substitutes. The high value shows they are close substitutes.
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🏢 Why YED and XED Matter
YED applications
- Firms predict how demand will change as the ECONOMY grows or shrinks
- Luxury goods firms benefit more from economic growth (high YED)
- Necessity firms are more stable during recessions (low YED)
- Developing countries: as income grows, demand shifts from inferior goods to normal goods
XED applications
- Firms monitor competitors' prices (high XED = close substitutes = price war risk)
- Complementary pricing — printers are cheap, ink is expensive (XED is negative between them)
- Competition regulators use XED to define markets (closer substitutes = same market)
In evaluation questions, link elasticity to stakeholders: How does this affect consumers? Producers? Government? And consider short-run vs long-run elasticity differences.