Income Elasticity of Demand Measurement
The following formula is used:
Income Elasticity of Demand = % Change in Demand Quantity / % Change in Income of ConsumerWhere:
- % Change in Demand Quantity = Change in Demand Quantity / Original Demand Quantity
- % Change in Income of Consumer = Change in Income of Consumer / Original Income of Consumer
Income Elasticity of Demand Types
Based on numerical value, the income elasticity of demand is divided into three classes as follows:
1. Positive income elasticity of demand
It refers to a condition in which demand for a commodity rises with a rise in consumer income and declines with a decline in consumer income. Commodities with positive income elasticity of demand are normal goods.
The upward slope implies that the rise in income contributes to a rise in demand and vice versa. There are three forms of positive income elasticity of demand stated as follows:
- Unitary – The positive income elasticity of demand will be unitary if the proportionate change in the amount of a product demanded equals the change in consumer income in due proportion.
- More than unitary – The positive income elasticity of demand will be more than unitary if the proportionate change in the amount of a product demanded is higher than the change in consumer income in due proportion.
- Less than unitary – If the change in the amount of a product demanded in due proportion is less than the change in consumer income in due proportion, positive income elasticity of demand will be less than unitary.
2. Negative income elasticity of demand
It refers to a condition in which demand for a commodity decreases with a rise in consumer income and increases with a fall in consumer income. Inferior goods are such commodities. For example, the demand for millet will decrease if the income of consumers increases since they will prefer to purchase wheat instead of millet. Thus, millet is an inferior good to wheat for customers.
The downward slope implies that the increase in income contributes to a fall in demand, and a decrease in income causes a rise in demand.
3. Zero income elasticity of demand
It corresponds to the situation when there is no impact of rising household income on commodity production. Such goods are termed essential goods. For example, a high-income consumer and a low-income consumer will need salt in the same quantity.
Uses of Income Elasticity of Demand
1. Forecasting demand
Forecasting demand applies to the idea that the income elasticity of demand tends to predict demand for commodities in the future. If there is a substantial change in wages, the change in demand for products will also be significant. This is because when buyers become aware of a shift in income, they will change their preferences and expectations for such products.
2. Investment decisions
The idea of national income is very important to businesses as it helps them to decide which sectors they should invest their money in. In general, investors tend to invest in markets where they can predict that the demand for commodities is related to a growth in national income or where the income elasticity of demand is greater than negligible.
Related Readings
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Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain good to a change in the real income of consumers who buy this good.
The formula for calculating income elasticity of demand is the percent change in quantity demanded divided by the percent change in income. With income elasticity of demand, you can tell if a particular good represents a necessity or a luxury.
- Income elasticity of demand is an economic measure of how responsive the quantity demanded for a good or service is to a change in income.
- The formula for calculating income elasticity of demand is the percentage change in quantity demanded divided by the percentage change in income.
- Businesses use the measure to help predict the impact of a business cycle on sales.
Income elasticity of demand measures the responsiveness of demand for a particular good to changes in consumer income.
The higher the income elasticity of demand for a particular good, the more demand for that good is tied to fluctuations in consumers' income. Businesses typically evaluate the income elasticity of demand for their products to help predict the impact of a business cycle on product sales.
Depending on the values of the income elasticity of demand, goods can be broadly categorized as inferior and normal goods. Normal goods have a positive income elasticity of demand; as incomes rise, more goods are demanded at each price level.
Normal goods whose income elasticity of demand is between zero and one are typically referred to as necessity goods, which are products and services that consumers will buy regardless of changes in their income levels. Examples of necessity goods and services include tobacco products, haircuts, water, and electricity.
As income rises, the proportion of total consumer expenditures on necessity goods typically declines. Inferior goods have a negative income elasticity of demand; as consumers' income rises, they buy fewer inferior goods. A typical example of such a type of product is margarine, which is much cheaper than butter.
Furthermore, luxury goods are a type of normal good associated with income elasticities of demand greater than one. Consumers will buy proportionately more of a particular good compared to a percentage change in their income. Consumer discretionary products such as premium cars, boats, and jewelry represent luxury products that tend to be very sensitive to changes in consumer income. When a business cycle turns downward, demand for consumer discretionary goods tends to drop as workers become unemployed.
The formula for income elasticity of demand is:
Income Elasticity of Demand = D 1 − D 0 D 1 + D 0 I 1 − I 0 I 1 + I 0 where: D 0 = Initial quantity demanded D 1 = Final quantity demanded I 0 = Initial real income I 1 = Final real income \begin{aligned}&\text{Income Elasticity of Demand} = \frac{ \frac { D_1 - D_0 }{ D_1 + D_0 } }{ \frac { I_1 - I_0 }{ I_1 + I_0 } } \\&\textbf{where:} \\&D_0 = \text{Initial quantity demanded} \\&D_1 = \text{Final quantity demanded} \\&I_0 = \text{Initial real income} \\&I_1 = \text{Final real income} \\\end{aligned} Income Elasticity of Demand=I1+I0I1−I0D1+D0D1−D0where:D0=Initial quantity demandedD1=Final quantity demandedI0=Initial real incomeI1=Final real income
Consider a local car dealership that gathers data on changes in demand and consumer income for its cars for a particular year. When the average real income of its customers falls from $50,000 to $40,000, the demand for its cars plummets from 10,000 to 5,000 units sold, all other things unchanged.
The income elasticity of demand is calculated by taking a negative 50% change in demand, a drop of 5,000 divided by the initial demand of 10,000 cars, and dividing it by a 20% change in real income—the $10,000 change in income divided by the initial value of $50,000. This produces an elasticity of 2.5, which indicates local customers are particularly sensitive to changes in their income when it comes to buying cars.
There are five types of income elasticity of demand:
- High: A rise in income comes with bigger increases in the quantity demanded.
- Unitary: The rise in income is proportionate to the increase in the quantity demanded.
- Low: A jump in income is less than proportionate to the increase in the quantity demanded.
- Zero: The quantity bought/demanded is the same even if income changes
- Negative: An increase in income comes with a decrease in the quantity demanded.
Income elasticity of demand describes the sensitivity to changes in consumer income relative to the amount of a good that consumers demand. Highly elastic goods will see their quantity demanded change rapidly with income changes, while inelastic goods will see the same quantity demanded even as income changes.
Since the value is positive, the good is elastic. It implies that for every 1% increase in income, people will demand 1.5x the number of goods. Thus, if the average income is $100,000 and at that level of income people desire 6 meals out per week, they would demand 9 meals out if income rose to $101,000.
Price elasticity of demand measures the change in percentage of demand caused by a percent change in price, rather than a percent change in income.
Yes, for example with certain "inferior" goods, the more money people have the less likely they are to buy cheaper products in favor of higher quality ones.
Inelastic goods tend to have the same demand regardless of income. Certain staples and basics such as gasoline or milk would not change with income—you'll still only need one gallon a week even if your income doubles.
Income elasticity of demand is the change in quantity demanded of a good or service in relation to the change in real income of a consumer that buys that good or service. Income elasticity of demand will denote whether a product is an essential item or a luxury item.
The higher the inelasticity of demand for a good or service, the more sensitive the demand for it is to fluctuations in consumer income. If a good or service has a high inelasticity of demand, it will experience a decline in demand when the real income of consumers decreases. If real income increases, it will see an increase in demand. If a good or service has a low inelasticity of demand, its demand will not significantly change regardless of what happens to the real income of consumers.