YED

YED, or income elasticity of demand, measures how the quantity demanded of a good responds to a change in consumer income. It is defined as YED = (% change in quantity demanded) / (% change in income), or approximately ΔQ/Q divided by ΔI/I when using arc elasticity to reduce bias. The sign and magnitude of YED indicate the type of good and the responsiveness of demand to income changes.

A positive YED means the good is a normal good, with higher income leading to higher quantity demanded. A negative YED indicates an inferior good, where higher income reduces demand. Distinguish between necessities and luxuries: YED between 0 and 1 signals a necessity with relatively inelastic demand to income, while YED greater than 1 indicates a luxury or superior good with highly elastic demand to income. Some goods may have YED close to zero, showing income inelastic demand, such as basic staples.

YED can be estimated from historical data by regressing changes in quantity demanded on changes in income, often controlling for other factors such as price. It can vary across markets, over time, and among consumer groups, reflecting preferences and income distribution. YED is distinct from the price elasticity of demand, which measures responsiveness to price changes rather than income, and from cross elasticity of demand, which measures sensitivity to the price of related goods.

Limitations include that YED is not constant along the demand curve, can be affected by taxation or wealth effects, and relies on reliable income data and stable preferences. In practice, economists use YED to analyze the impact of income changes on demand, inform production planning, and study consumer behavior.