PED and YED

YED Definition

YED stands for income elasticity of demand and can be defined as follows.

Demand is not only affected by price (PED) but also by consumer income (YED). YED measures how much the demand for a product or service changes if there is a change in real income. We measure YED to answer the following question: if consumers' income changes, how much does demand for goods and services increase or decrease? Or does it stay the same?

Many products have a positive income elasticity of demand. As consumers' income increases, they demand more goods and services.

Calculating PED and YED

Now that we understand the meaning of price and income elasticity of demand let's examine how to calculate PED and YED.

PED and YED: Calculating PED

Price elasticity of demand can also be defined as the percentage change in quantity demanded divided by the percentage change in price. To calculate the price of elasticity of demand, we use the following formula:

\(\hbox{PED}=\frac{\hbox{% Change in Quantity Demanded}}{\hbox{& Change in Price}}\)

PED and YED: Calculating YED

Income elasticity of demand can also be defined as the percentage change in quantity demanded by the percentage change in real income. To calculate the income of elasticity of demand, we use the following formula:

\(\hbox{PED}=\frac{\hbox{% Change in Quantity Demanded}}{\hbox{& Change in Income}}\)

Difference between PED and YED

Besides the differences in definition and calculation, the interpretation of PED and YED also vary.

PED and YED: Interpreting PED

After calculating PED, we need to understand how to interpret its value. There are three different expected outcomes:

|PED| > 1: Demand is elastic if the absolute value of PED is greater than one. Elastic demand implies that a small price change will result in a significant shift in demand. Elastic demand is usually observed for substitutable goods.

Demand also tends to be elastic for luxury goods.

|PED| <1: if the absolute value of PED is smaller than one, demand is inelastic. Inelastic demand implies that a small price change will result in an even smaller change in demand. In other words, even if the price changed significantly (significant increase or decrease), demand would not change much. Inelastic demand is common for goods that are necessities.

|PED| = 1: if the absolute value of PED is equal to one, it means that demand is unitary.

This type of elasticity is relatively uncommon. Unitary elastic demand would imply that if a company sold 100 units of a product at £100 and increased its price to £101, demand would decrease to 99 units.

Figure 1 below summarises the relationship between the value of PED and the elasticity of demand.

FIg. 1 - Interpreting PED

PED and YED: Interpreting YED

Similarly to PED, we need to understand how to interpret the value of YED. There are three different expected outcomes:

0 <YED <1: If YED is larger than zero but smaller than 1, it implies that an increase in income will lead to an increase in quantity demanded. This tends to be the case for normal goods. Normal goods exhibit a positive relationship between income and demand. Normal goods include products like clothing, household appliances, or branded food items.

YED> 1: If YED is much higher than one, it implies income elastic demand. This means that a change in income will result in a proportionally larger change in quantity demanded. A YED larger than 1 tends to be the case for luxury goods - as average income increases, consumers tend to spend more on luxuries like designer clothes, expensive jewellery, or luxury holidays.

YED <0: If YED is smaller than zero, it implies a negative elasticity of demand. This means that an increase in income will result in a proportionally larger decrease in the quantity demanded. In other words, consumers demand less of this product when income increases. A YED smaller than zero tends to be the case for inferior goods.

An example of inferior goods would be own-branded grocery items or budget food items.

Figure 2 below summarises the relationship between the value of YED and the type of goods associated with it.

Fig. 2 - Interpreting YED

Importance of PED and YED

So, why is it important to understand PED and YED? Marketers always seek to understand consumer behaviour. They look for changes in consumer attitudes, perceptions, and buying behaviour. Therefore, the way consumers perceive and respond to prices will be of interest to marketers.

For instance, if a business is selling luxury products, it knows that the demand for its products is elastic. As a result, a company selling luxury holiday packages might decide to introduce price promotions during a time when the average consumer income is lower than in previous years.

On the other hand, consider a supermarket that makes most of its revenue from selling lower-cost private label (store brand) products. Suppose the economy is experiencing healthy growth and consumers earn more money on average. In that case, the supermarket might consider introducing a new product line or brand with a selection of higher-end consumer goods.