Income Elasticity of Demand

What is Elasticity?

• Elasticity measures the responsiveness of demand to a change in a relevant variable- such as price or income

What is the Income Elasticity of Demand:

• The income elasticity of demand measures the extent to which the quantity of a product demanded is affected by a change in income

Income Elasticity of Demand equation:

• % Change in Quantity Demanded/ % Change in Income

Income Elasticity of Luxury items:

• Income elasticity is more than 1

• As income grows, proportionally more is spent on luxuries

  • Consumer goods

  • Expensive holidays

  • Branded goods

Income Elasticity of Necessities:

• Income elasticity is less than 1, but more than 0

• As income grows, proportionally less is spent on necessities

  • Staple groceries (e.g. bread and milk)

  • Own-label goods

Interpreting Income Elasticity of Demand:

• Most normal products

  • A rise in consumer income will result in a rise in demand

  • A fall in consumer income will result in a fall in demand

• Extent of the change (elasticity)

  • This will vary depending on the type of product (e.g. luxury vs necessity)

Inferior Goods (negative income elasticity):

• For inferior goods, as income rises demand actually falls

• IED is negative (less than 0)

• Why does demand fall?

  • Consumers switch to better alternatives

  • Substitute products become affordable