Chapter 1 – the market system - The Good, the Bad and ...



Chapter 9 – yED (Week 7)

|Objectives of the chapter |

|Supply curve |Define yED and the importance of negative or positive |Define: yED, |

| |value |Describe/outline: positive value of yED (normal good), |

| |Explain that goods can be classified as normal and |negative value (inferior) |

| |inferior in terms of yED |Explain/distinguish/draw: in a demand curve: ↑y → ∆↑Qd..or ∆D |

| |Identify and draw how changes in income would affect |for a good…BECAUSE y is a _________ of demand |

| |the demand for a good |Evaluate/discuss: link yED to why the demand curve is |

| |Explain why some goods might be normal and others |downward-sloping |

| |inferior | |

| |Interpret yED values and explain the underlying | |

| |reasons for the values | |

| | | |

| | | |

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ACCEPT NO SUBSTITUTES! (ON THE ROAD IN THE YUCATAN, MEXICO, JULY 2007)

Notes on syllabus:

• ..diagrams NOT required

• yED – definition

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• Formula – % ∆Qd / % ∆y

o it is the change in y which causes the change in Qd

o note that we are speaking of relative change of Qd due to a relative change in y

o positive value; normal goods (most goods are “normal”)

o negative value; inferior goods (such as public transportation…potatoes maybe…)

• Main determinants of yED – basically just ask yourself what you will do with 10% more income, buy shoes or corn flakes?!

o goods with snob appeal…luxury…; high yED

o goods which are necessities…basic items…associated with low income; low yED

o goods which are considered so basic/low income that they are eschewed by those who can afford it; negative yED (inferior goods)

• Examples – you need to be able to give examples of goods with low/high yED and explain why the good is sensitive to changes in income

• Normal goods – when y↑ and Qd ↑ then this is a normal good (positive yED value)

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o Most goods are normal, e.g. have positive values of yED

o If a good has a yED value greater than 1, one uses the term superior good (Mr Steele has a penchant for Patek Philippe wrist watches)

• Inferior goods – when y↓ and Qd↑ then you have an inferior good (negative yED value)

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o Few good examples of inferior goods – perhaps potatoes and rice in some cases

• Discussion (refer to the Engel curve here)

o It largely depends on who is buying the good as to whether it is income elastic or not – a good restaurant meal is likely to be far more income elastic for a lower income person than for a middle income person – and it might even be an inferior good for high income people who decide to hire a chef instead! The same might go for air tickets and cinema.

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Revision questions:

1. Define yED and explain the importance of negative or positive values.

2. If demand falls by 10 percent due to a 5% rise in incomes, what is the value of yED?

3. Why might paperclips and toilet paper have low yED values?

4. How might recessions hit

a. Demand for low-cost air travel

b. Demand for luxury cruises

c. Demand for BMW cars

d. Demand for expensive schooling

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Definition: Income elasticity of demand

Income elasticity of demand – yED – measures the responsiveness of demand, i.e. the relative (percentage) change in the quantity demanded for a good due to a relative (percentage) change in income. (The lower case “y” signifies personal income, since upper case “Y” is reserved for national income.)

Summary and revision

1. Income elasticity of demand (yED) shows the sensitivity of demand for a good with respect to a change in income

2. The formula for yED is "%Qd / "%y

3. A positive value of yED means the good is a normal good

i. Normal goods in diagrams; an increase in income leads to an increase in demand (demand curve shifts right)

4. A negative value of yED means the gooThe formula for yED is ∆%Qd / ∆%y

A positive value of yED means the good is a normal good

Normal goods in diagrams; an increase in income leads to an increase in demand (demand curve shifts right)

A negative value of yED means the good is an inferior good

i. Inferior goods in diagrams; an increase in income leads to a decrease in demand (demand curve shifts left)

5. LDCs are often producers of primary goods which have low income elasticities of demand. As incomes in developed countries increase, demand for primary goods increase proportionally less. As prices for secondary goods – which have a higher income elasticity of demand – rise more than prices for primary goods, LDCs will have to export more primary goods for any given quantity of imported of secondary goods. This means that the terms of trade for LDCs worsens.

Definition: Inferior good

An inferior good is negatively correlated to income, i.e. the yED is negative. A rise in income decreases demand for inferior goods. A fall in income increases demand for inferior goods.

Definition: Normal good

A normal good is positively correlated to income, i.e yED is positive. A rise in income increases demand for normal goods. A fall in income decreases demand for normal goods.

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