Income Elasticity of Demand

Income Elasticity of Demand

Income Elasticity of Demand refers to change in the quantity demanded for certain goods with reference to change in the income of the person or consumer and all other factors being constant. It measures the relationship of change in quantity demanded to change in the income as people tend to spend more in case of an increase in real income.

Explanation

Income Elasticity of Demand measures how much there is a change in demand for certain goods with a change in income. As there is a normal tendency that people will try to improve the standard of living in case of an increase in income. The demand for luxury or non-essential goods will increase in case of an increase in the real income of the consumer to maintain a high standard of living. Income is an important element of consumer demand hence most of the companies tend to produce goods and set prices taking into account the average income of the consumers to increase the demand for their products.

Formula

Income Elasticity of Demand is measured by the following formula:

From this, it can be analyzed that which goods are demanded more if the average income of the consumer increases.

Practical Example

The income of households increases by 10% and demand for necessity goods like pulses increases by 3%.

Income Elasticity of demand = Percentage change in quantity demanded / Percentage change in Income

= 3/10

= 0.3

The income of household increases by 10% and demand for electronics necessities like television, washing machine, etc. increases by 15%

Percentage change in quantity demanded / Percentage change in Income

= 15/10

= 1.5

The income of households increases by 10% and the demand for necessities like wheat and bajra decreased by 2%.

Percentage change in quantity demanded / Percentage change in Income

= (-) 2/10

= (-) 0.20

The income of households increases by 10% and the demand for other necessities like salt, sugar, etc. increased by 10%.

Percentage change in quantity demanded / Percentage change in Income

= 10/10

= 1

The income of households increases by 10% and demand for machinery spares does not increase at all.

Percentage change in quantity demanded / Percentage change in Income

= 0/10

= 0

Interpretation of Examples

  • Since Income Elasticity is less than 1, pulses are normal and necessity goods and normal goods have positive elasticity of demand and income elasticity of demand in case of normal goods ranges between 0 and 1.
  • Since Income Elasticity is greater than 1, electronic goods are luxury and necessity goods and luxury goods have the elasticity of demand which is greater than 1 i.e. demand rises more than proportionate change in income.
  • Since Income Elasticity is less than 0, wheat and Bajra are necessity goods and they might be considered as inferior goods. Negative income elasticity is where demand falls and income rises this happens when superior goods are available and due to a change in the income consumers want to spend on superior goods rather than on inferior goods.
  • Since Income Elasticity is equal to 1, sugar, salt, etc. being the type of products which are to be used in limit hence increase in the demand will be exactly same as an increase in the income and this type of demand is called as unitary elastic demand i.e. 1
  • Since Income Elasticity is equal to 0, machinery spares are types of products which are to be used in the same quantity even in case of income rises the goods being the minimum usage goods and demand for that type of goods is equal to 0. i.e. zero income elasticity demand.

Relevance and uses

Income Elasticity of demand is used when:

  • It is used for deciding the price of the product.
  • It helps the companies to produce the goods as per needs and income elasticity to increase the demand for their products.
  • Negative income elasticity is associated with inferior goods whereas positive income elasticity is associated with normal goods, unitary income elasticity is associated with necessity goods and zero income elasticity occurs when income is not associated with the change in demand.

Final Thought

Income Elasticity of demand is the measure for change in quantity demanded to change in the income, through which the effect of chan demand with reference to changes in income is measured and the price of the goods is fixed accordingly. The supply or production of the goods is also to be measured with reference to the income elasticity of the demand. There are types of income elasticity and they are positive income elasticity, negative income elasticity, unitary income elasticity, and zero income elasticity. Negative income elasticity occurs when goods are inferior in nature, positive income elasticity occurs when with normal goods, unitary income elasticity is associated with necessity goods and zero income elasticity occurs when income is not associated with the change in demand.

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Related Articles

  1. Demand
  2. Determinants of Demand
  3. Law of Demand
  4. Rationale of law of demand
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One thought on “Income Elasticity of Demand

  1. I’m not sure where you are getting your info, but great topic.
    I needs to spend some time learning more or understanding more.
    Thanks for wonderful info I was looking for this info for my mission.

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