Income Elasticity and Cross Elasticity of Demand

This lesson covers two further measures of elasticity: income elasticity of demand (YED) and cross elasticity of demand (XED). These concepts allow economists to analyse how demand responds to changes in income and to changes in the prices of related goods. Both are important for understanding consumer behaviour, business strategy, and government policy at A-Level.

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Income Elasticity of Demand (YED)

Key Definition: Income elasticity of demand (YED) measures the responsiveness of the quantity demanded of a good to a change in consumer income, ceteris paribus.

The YED Formula

YED = Percentage change in quantity demanded / Percentage change in income

YED = (%ΔQd) / (%ΔY)

Unlike PED, the sign of YED is economically meaningful — it tells us whether the good is normal or inferior.

Worked Example

A consumer's income rises from £30,000 to £33,000 per year (a 10% increase). Their demand for organic food increases from 50 units per month to 60 units per month (a 20% increase).

YED = +20% / +10% = +2.0

This is positive and greater than 1, indicating organic food is a normal good with income-elastic demand — a luxury.

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Interpreting YED Values

YED Value	Classification	Description	Example
YED > 1	Normal good (luxury / income-elastic)	Demand increases more than proportionately as income rises	Foreign holidays, designer clothes, organic food
0 < YED < 1	Normal good (necessity / income-inelastic)	Demand increases less than proportionately as income rises	Bread, milk, toothpaste, electricity
YED = 0	Income-independent	Demand does not change when income changes	Salt (approximately)
YED < 0	Inferior good	Demand falls as income rises (consumers switch to better alternatives)	Value-brand food, bus travel, instant noodles

Normal Goods vs Inferior Goods

• Normal goods have positive YED — demand rises as income rises. Most goods are normal goods.
• Inferior goods have negative YED — demand falls as income rises because consumers can now afford higher-quality substitutes.

UK Example: As UK living standards have risen, demand for budget supermarket own-brand products (inferior goods with negative YED) has fallen among higher-income consumers, while demand for premium products (normal goods with positive YED) has increased. However, during the cost-of-living crisis of 2022-23, rising food prices and falling real incomes caused consumers to trade down to cheaper brands — consistent with the YED analysis.

Exam Tip: The distinction between necessities and luxuries is about the magnitude of YED, not the sign. Both have positive YED (they are both normal goods). Necessities have 0 < YED < 1; luxuries have YED > 1. Do not confuse this with the normal/inferior distinction, which is about the sign.

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YED and Business Strategy

Understanding YED helps firms plan for changes in the economic cycle:

• During economic growth (rising incomes): demand for luxury goods (YED > 1) increases rapidly. Firms selling luxuries benefit disproportionately from economic booms. Examples: premium car manufacturers, high-end restaurants, travel companies.

• During recession (falling incomes): demand for luxury goods falls sharply, while demand for inferior goods (YED < 0) may actually increase as consumers trade down. Examples: demand for value supermarkets like Aldi and Lidl tends to rise during recessions.

• Necessity goods (0 < YED < 1) are relatively stable across the business cycle — demand changes only slightly with income fluctuations.

Stage of Business Cycle	Luxury goods (YED > 1)	Necessities (0 < YED < 1)	Inferior goods (YED < 0)
Boom	Demand rises sharply	Demand rises slightly	Demand falls
Recession	Demand falls sharply	Demand falls slightly	Demand rises

Exam Tip: In questions about the business cycle, link YED to the type of goods a firm produces. A firm selling luxury goods should diversify into necessities to reduce vulnerability to recessions. This is strong evaluation.

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Cross Elasticity of Demand (XED)

Key Definition: Cross elasticity of demand (XED) measures the responsiveness of the quantity demanded of Good A to a change in the price of Good B, ceteris paribus.

The XED Formula

XED = Percentage change in quantity demanded of Good A / Percentage change in price of Good B