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Income and cross elasticity of demand

Edexcel IAL Economics · WEC11 Markets in action

Income elasticity tells firms what happens to demand as incomes change; cross elasticity tells them how their sales depend on other goods' prices. This lesson covers spec point 1.3.2.3 (h) and (i).

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Income elasticity of demand (YED)

YED = % change in quantity demanded / % change in real income.

The sign tells you the type of good:

Normal good: YED positive. Demand rises when income rises.

- Income inelastic (between 0 and +1): necessities such as bread, basic clothing. Demand rises, but by a smaller percentage than income.

- Income elastic (more than +1): luxuries such as foreign holidays, restaurant meals, sports cars.

Inferior good: YED negative. Demand falls as income rises because consumers switch to better alternatives: the cheapest own-brand foods, long-distance bus travel instead of flying.

The specification also asks you to interpret extremes: YED = 0 means demand does not respond to income at all (perfectly income inelastic).

Cross elasticity of demand (XED)

XED = % change in quantity demanded of good A / % change in price of good B.

Substitutes: XED positive. A rise in the price of B makes people switch to A. The larger the value, the closer the substitutes (two brands of petrol may have a high XED).
Complements: XED negative. A rise in the price of B reduces demand for B and so for A, which is used with it (cars and petrol, printers and ink).
Unrelated goods: XED = 0 (or close to it): bread and car tyres.

Always write the sign. In 'calculate' questions, the sign is part of the answer.

Diagram links

YED and XED are about shifts of the demand curve, not movements along it. A rise in income shifts the demand for a normal good right and for an inferior good left. A rise in the price of a substitute shifts demand for the good right; a rise in the price of a complement shifts it left.

Worked example

Average real income rises from $30,000 to $33,000. Demand for restaurant meals rises from 200 to 250 a week, and demand for instant noodles falls from 500 to 470. Calculate each YED and classify the goods.

% change in income = 10%.
Restaurant meals: %ΔQ = 25%, YED = 25 / 10 = 2.5: positive and greater than 1, a normal luxury good.
Instant noodles: %ΔQ = -6%, YED = -6 / 10 = -0.6: negative, an inferior good.

Answer: Restaurant meals YED = 2.5 (luxury); noodles YED = -0.6 (inferior).

Key idea: YED: positive = normal (0 to 1 necessity, over 1 luxury); negative = inferior. XED: positive = substitutes, negative = complements, zero = unrelated. Both are about shifts in demand.

Check yourself

Real incomes rise by 4% and demand for organic vegetables rises by 10%. Calculate the income elasticity of demand.
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2.5. YED = 10 / 4 = 2.5: a normal, income elastic (luxury) good.
The price of good B rises from $2.00 to $2.40, and the quantity demanded of good A rises from 1,500 to 1,800. Calculate the cross elasticity of demand of A with respect to B.
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1.00. %ΔQ of A = 20%; %ΔP of B = 20%; XED = 1. Positive, so A and B are substitutes.
A good has an income elasticity of demand of -0.6. It is
- a luxury good
- a normal necessity
- a complement
- an inferior good
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an inferior good. Negative YED means demand falls as income rises.
Which YED value indicates a luxury good?
- +1.8
- +0.4
- -0.5
- 0
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+1.8. Luxuries are normal goods with YED greater than +1.
The XED between petrol and large cars is likely to be
- positive, because they are substitutes
- zero, because they are unrelated
- negative, because they are complements
- always exactly -1
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negative, because they are complements. A rise in the price of petrol reduces demand for large cars.
Which XED suggests the closest substitutes?
- +3.0
- +0.2
- -3.0
- 0
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+3.0. A large positive value means a small price change in one causes a large switch to the other.
Explain the difference between a normal good and an inferior good, using income elasticity of demand.
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A normal good has a positive YED: demand rises as real income rises. An inferior good has a negative YED: demand falls as income rises because consumers switch to better quality alternatives.. Define each with the sign of YED and the direction of the change in demand.

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Sources

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.