# Income elasticity of demand Geri sells conservatory furniture. His product ranges from the basic two seater sofa and two chairs, priced at just £199 to a deluxe set priced at £2500. Last year...

Income elasticity of demand

Geri sells conservatory furniture. His product ranges from the basic two seater sofa and two chairs, priced at just £199 to a deluxe set priced at £2500. Last year Geri sold 125 deluxe sets. Incomes in the area are forecast to increase by 3.2% the next year.

1) What was Geri´s sales revenue from deluxe sets last year?

2) Geri predicts that YED for his deluxe range is 1.25. What % change in demand would he forecast?

3) What then is Geri's predicted sales revenue from the deluxe range for next year?

4) For the basic set, Geri forecast his YED as -0.8. What percentage change in demand would this lead to?

5) Why might Geri's complete portfolio have a positive YED?

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The furniture Geri sells is priced at: Basic set £199, deluxe set £2500.

We are told that last year Geri sold 125 deluxe sets. Incomes in the area are forecast to increase by 3.2% the next year.

**1)** What was Geri´s sales revenue from deluxe sets last year?

*Revenue* is the amount earned through sales before deducting costs. If Geri sold 125 deluxe sets, and they are priced at £2500, then the revenue taken from these sales is

£2500 x 125 = **£312,500**

**2)** Geri predicts that YED for his deluxe range is 1.25. What % change in demand would he forecast?

YED is *income elasticity of demand, *which is defined by

YED = % change in quantity demanded (QD)/ % change in income (1)

We are told that the forecasted % change in income is 3.2%, so if the YED = 1.25% then, using equation (1) we have that

% change in quantity demanded = % change in income x YED = 3.2 x 1.25 = **4%**

**3)** What then is Geri's predicted sales revenue from the deluxe range for *next year*?

From part 2) we have that the % change in quantity demanded is 4%. Because 4% more deluxe sets are predicted to be purchased, the revenue is also predicted to go up 4%, from £312,500 to 1.04 x £312,500 = **£325,000**

**4)** For the basic furniture set, Geri forecast his YED to be -0.8. What percentage change in demand would this lead to?

From equation (1), if YED = -0.8 and % change in income = 3.2% as given, then

% change in demand = % change in income x YED = 3.2 x -0.8 = **-2.56%**

**5)** Why might Geri's complete portfolio have a positive YED?

The combined YED is the YED of all types of furniture sold. Depending on how many of each type of set Geri sells, this might combine to be positive or negative. The demand for deluxe sets is predicted to go up by 4%, but the demand for basic sets is predicted to go down by -2.56%. If enough deluxe sets are sold as opposed to basic sets the YED will swing in favour of the YED for deluxe sets, that is, a positive YED. But on the other hand the YED could be negative if enough basic sets are sold as opposed to deluxe sets.