YED Business relevance:

Introduction

1. Income elasticity of demand (YED) is a measure of the

responsiveness of demand for a given good to the change in
income, ceteris paribus. It provides information on the direction
and magnitude of change in demand given a change in income.
2. Profit-seeking firms would be motivated to find means to
increase their Total Revenue (TR), thereby possibly also
increasing their economic profits, which is the amount by which
Total Revenue exceed Total costs. This can be accomplished
using the concept of YED.
3. Primary products are products which are in their raw form and
have not gone through manufacturing or processing. Examples
include coal and agricultural products. On the other hand,
manufactured products are products that have been processed
from raw materials, for example consumer products like TVs.

Explanation

1. The YED for primary products tend to be the lower than that of
manufactured products and services. This is because primary
products tend to be of the highest degree of necessity, as they
are often essential in the production of other goods. For
instance, cotton is used in the production of clothing. As a result,
primary products tend to be normal necessity goods, with a YED
value between 0 and 1.
2. On the other hand, manufactured products are often of lower
degree of necessity (higher YED value), followed by services
(like entertainment or travel) which have the lowest degree of
necessity and oftentimes, considered luxury goods (YED > 1).

Thesis: Usefulness of YED

1. Knowledge of YED enables a firm to develop a production and

marketing strategy, both in terms of the amount of output and the
type of good or service.
2. Over time, as countries experience economic growth, the real
income per capita is likely to increase, which causes the demand
for primary and manufactured goods and services to increase.
3. The demand for primary goods is likely to increase less than
proportionately to the increase in income, whereas the demand
for manufactured goods is likely to increase by a greater extent
and the demand for services being income elastic will increase
more than proportionately. The converse holds true in times of
an economic downturn.
4. Insert Figure on different relative extents of shifts in Dd curves
for Primary vs Manuf Goods & Services. (Taught in class).
5. Consequently, this allows the producers to decide on an
appropriate production strategy. In times of economic growth,
producers of primary products will want to increase output but
not drastically. In contrast, producers of manufactured goods
and especially services should seek to expand output by a lot
more. This will allow them to realise significantly more sales and
hence revenue and profits.
6. Similarly, coffee growers may want to produce more Arabica
beans as demand increases even more. Hence, coffee
producers could sell coffee made from the more premium
Arabica beans, instead of the more common Robusta beans.
7. Producers of manufactured goods might also be incentivised to
expand into the production of products that are considered more
luxury or high-class.
8. In contrast, during a recession or times of economic downturn, a
firm should consider focusing on the production of normal
necessity goods (for which the decrease in demand is less than
proportionate), or even inferior goods (whose demand actually
increases). A coffee grower may choose only to produce
Robusta beans.
9. Large companies should consider producing a range of products
with different YED values for greater revenue and profit stability.
For example, the Volkswagen Group sells a large variety of
vehicles, including luxury passenger cars under brands such as
Bentley, Lamborghini and Porsche, as well as more pedestrian
offerings under brands like SEAT or Skoda.
10. The Group also sells commercial vehicles such as trucks.
These vehicles vary widely in YED – luxury vehicles have a YED
value that is positive and greater than one, whereas its mass-
 market brands have a YED that is below 1 or even
negative. This allows the company as a whole to be versatile –
the company can easily vary the focus in terms of production
according to changes in income, thereby ensuring stability in
sales and profitability regardless of economic performance.

Anti-Thesis: Limitations of YED analysis

1. YED data might not be completely accurate. It is hard for market

research and economic studies to accurately simulate
consumers’ behaviour in reaction to changes in income.
Furthermore, conducting such research and studies takes long
periods of time – consequently, the collated data might already
be out-of-date and hence inaccurate by the time the firm decides
to act on them.
2. Knowledge of YED might be insufficient to determine
consumption effects, since the ceteris paribus assumption often
does not hold true in real life. When planning its product line-up
and production quantities, a firm has to assess not only changes
in income levels but also take into consideration other factors
that might have an impact on the demand for its product.
3. For example, an increase in a nation’s income might imply a rise
in the demand for technologically advanced televisions, but
consumers will have a range of brands from which to choose.
Some firms could experience little effect on sales if consumers
have a preference for substitute brands. Hence, firms need to
take into account of other factors such as consumer tastes and
preferences, and not merely YED values.
4. The use of YED is mainly geared towards increasing revenues.
However, to maximise profits, costs of production also have to
be considered. By widening range of products and also by
producing more luxury versions, higher unit costs of production
may be incurred.
5. As production and marketing strategies take time to implement,
firms may attempt to use economic growth forecasts to make
their decisions. However, such forecasts may be inaccurate,
leading to wrong decisions that reduce profits instead.

Concluding Section
1. While knowledge of YED is important as it does provide a firm
with useful and relevant information to help achieve its goals,
there are limitations to its application.
2. The knowledge of YED would be more important for firms in
manufacturing and services since the demand they face would
be more sensitive to income changes.
3. Knowledge of other elasticities, such as the price elasticity of
demand (PED) and XED would also be important in guiding the
firm’s strategies, as many factors have to be taken into account.
4. Information regarding costs of production would also be vital.
The mixed economy system, where both the private and public sector play a
role in resource allocation, is the most common form of economic system.

(a) Explain, using examples, why merit goods cannot be classified as public
goods. [8]
(b) Discuss the desirable attributes of a mixed economy and whether it is
always superior in raising the people’s welfare to a planned economy. [12]

a). Merit goods are goods that will be underprovided when left to the market
to provide. This is due to imperfect information. Education, for example,
consumer do not fully aware the benefits of getting an education, some chose
not to go to school. Thus, under-provision.

It is not non-rivalry. Consumption by one does not reduce the amount

available for the next person. But not true for merit goods. Consumption of
MG, example healthcare, reduce the amount available to the next patient.
Only a limited number of beds, medicine, equipment, doctors and nurses. So, it
is not non-rivalry. It is not non-rivalry. Consumption by one does not reduce
the amount available for the next person. But not true for merit goods.
Consumption of MG, example healthcare, reduce the amount available to the
next patient. Only a limited number of beds, medicine, equipment, doctors and
nurses. So, it is not non-rivalry. It is not non-excludable. Once provided, cannot
stop the next person from using it. In MG, the next consumer can be stopped
from using it. Hospital again, admission can be controlled. So, MG is not non-
excludable.

Neither non-rivalry nor non-excludable, cannot be classified as public goods. It

is a private good.

b). Advantages of Mixed economy

a. Mixed economy with a private sector. Efficient price mechanism in allocating

resources. Shortages and surplus in the market can be eliminated efficiently
through price signals. leads to overall greater efficiency in resource allocation.
b. Mixed economy with a private sector: Private sector more robust and lead to
greater economic growth in the long run. Income rises.

c. Mixed economy with a private sector: Economic agents, eg. businessmen and
entrepreneurs, more motivated and dynamic in bringing new products, new
innovation to respond to consumer changing and varied demand for goods and
services.

Disadvantages of a mixed economy

a. Greater income inequality

b. Externality cause by the private sector who disregard cost to the third party.

Evaluation: Is a mixed economy always preferable to a planned economy?

a. In the LR, mixed economy deliver greater economic growth and lead to
higher income and standard of living. So, it is generally desirable.

b. Mixed economy is also more volatile, with greater risk of economic recession
and fluctuation. Planned economy is more stable.