What is Income Elasticity of Demand?

There are different factors that affect demand, such as the income of the consumer, the price of the commodity, the availability of close substitutes, and more. But what exactly is income elasticity of demand?

To clearly understand the income elasticity of demand, certain terms would need to be broken down to have a clearer understanding and gain clarity of what it is all about.

What is Demand?

Demand is an economic theory that refers to a consumer's desire to buy products and services as well as their readiness to pay a price for them.

If all other conditions remain constant, a rise in the price of a good or service will reduce demand, and vice versa.

The total quantity desired for a given good by all consumers in a market is known as market demand.

And the overall demand for all products and services in an economy is known as aggregate demand.

Having considered what demand is, we take a look at what elasticity is as well.

Elasticity Defined

Elasticity is a measure of a variable's responsiveness to a change in another variable, most frequently the change in quantity demanded in relation to changes in other variables like price.

It is a term used in economics to describe the change in the aggregate quantity demanded of a good or service in response to price changes.

The degree to which people, consumers, or suppliers adjust their demand or the amount supplied in reaction to price or income changes is referred to as price elasticity in business and economics.

When the elasticity number is larger than 1.0, it means that a change in the price of a good or service affects demand more than proportionally. A number less than 1.0 indicates that demand is relatively price-insensitive, or inelastic.

In an inelastic situation, when prices rise, customers' buying habits remain relatively unchanged, and when prices fall, consumers' buying habits remain relatively unchanged.

Types of Elasticity

• Elasticity of Demand.

• Cross Elasticity.

• Price Elasticity of Supply.

• Income Elasticity.

What is Income Elasticity of Demand?

The relationship between a consumer's income and the demand for a particular good is measured by the income elasticity of demand. It could be positive or negative, or even neutral to a certain product.

The responsiveness of the quantity demanded for a specific good to a change in the real income of consumers buying it, all other things being equal, is referred to as income elasticity of demand.

The percentage change in quantity demanded divided by the percentage change in income is the formula for estimating the income elasticity of demand.

The higher the income elasticity of demand for a specific good, the more that demand is influenced by changes in consumer income. Businesses, for example, commonly assess the income elasticity of demand for their products in order to forecast the influence of a market cycle on product sales.

Goods can be divided into inferior and normal categories based on the income elasticity of demand values.

Income elasticity of demand metrics can be positive or negative, and they've been used to categorize products as normal, inferior goods, necessities, or luxuries.

If the quantity demanded of a given product drops as a result of rising income, it is considered an inferior good. A normal good would be the total opposite.

Normal goods have a positive income elasticity of demand, which means that when incomes rise, more items at each price level are sought.

Normal goods with a demand elasticity of zero to one are commonly referred to as necessity goods, which are products and services that people will purchase irrespective of their income levels.

Tobacco, haircuts, water, and electricity are examples of these types of goods and services.

The fraction of overall consumer expenditures on necessities often decreases as income grows. Consumers buy fewer inferior items as their income grows because inferior commodities have a negative income elasticity of demand.

Also, luxury goods are a form of normal good that has demand elasticities greater than one.

In response to a percentage change in their income, consumers will buy proportionately more of a certain good.

Exotic vehicles, yachts, and jewelry are examples of consumer discretionary products that are very susceptible to variations in consumer income.

When an economic cycle turns down, consumer discretionary goods demand tends to fall as workers lose their jobs.

Types of Income Elasticity of Demand

There are three major types of income elasticity of demand and they are;

1. Positive Income Elasticity of Demand

Income elasticity of demand is positive when a proportionate change in a consumer's income increases demand for a product and vice versa.

The income elasticity of demand for normal goods is often positive.

Types of Positive Income Elasticity of Demand

Unitary income elasticity of demand, less than unitary income elasticity of demand, and more than income elasticity of demand are the three main types of positive income elasticity of demand.

• Unitary. If the proportionate change in the amount of a good demanded equals the change in consumer income in due proportion, the positive income elasticity of demand will be unitary.

• Less than Unitary. Positive income elasticity of demand is less than unitary if the change in the amount of a good demanded in due proportion is less than the change in consumer income in due proportion.

• More than Unitary. If the proportionate change in the amount of a good demanded is greater than the change in consumer income in due proportion, the positive income elasticity of demand will be greater than unitary.

2. Negative Income Elasticity of Demand

It describes a situation in which demand for a commodity falls as consumer income rises and rises as consumer income falls. Such commodities are inferior goods.

3. Zero Income Elasticity of Demand

The income elasticity of demand is zero when a proportionate change in a consumer's income has no effect on their demand for a product.

It usually happens with necessities like salt and gas. These goods are known as essential products.

Uses of Income Elasticity of Demand

1. Demand forecasting. The concept of forecasting demand refers to the premise that the income elasticity of demand tends to predict future demand for commodities. If earnings shift significantly, the demand for items will vary dramatically as well.

Because when consumers become aware of a change in income, their choices and expectations for such things will change.

2. Decisions on investments. The concept of national income is particularly significant to businesses because it lets them determine where to invest their money.

In a broad sense, investors prefer to invest in markets where they can forecast that commodity demand is linked to increase in national income or where demand elasticity is greater than zero.

Factors Affecting Income Elasticity of Demand

• Consumer income in a country.

• Product nature.

• The pattern of consumption.