Income Elasticity of Demand
What is Income Elasticity of Demand?
Income elasticity of demand measures how responsive the quantity demanded is to a change in consumers' income.
It is calculated as the percentage change in quantity demanded divided by the percentage change in income. Demand is considered a normal good if the ratio is positive, meaning demand increases as income increases. Demand is considered an inferior good if the ratio is negative.
Income Elasticity of Demand: a worked example
A household's income rises from $40,000 to $44,000, an increase of 4,000/40,000 = 10 percent. Its restaurant meals per year go from 24 to 30, an increase of 6/24 = 25 percent, so income elasticity is 25/10 = 2.5. Positive means restaurant meals are a normal good for this household, and above 1 means they are income elastic, the pattern usually labelled a luxury. Over the same year the household's instant noodle packs fall from 200 to 180, a change of -20/200 = -10 percent, giving -10/10 = -1, so noodles are inferior for this household.
The mistake students make with income elasticity of demand
Students label a good inferior because it is cheap or low status. Inferior is a claim about behavior, not quality: a good is inferior only if buyers purchase less of it when their income rises and prices hold still. The second half of this error is treating the label as permanent. The same good can be normal for a household at a low income and inferior for that same household later, so the classification always belongs to a particular group over a particular income range.
Income Elasticity of Demand questions
What income elasticity makes a good a luxury?
A good counts as a luxury, or income elastic, when its income elasticity is greater than 1, meaning quantity demanded grows faster in percentage terms than income does. An elasticity between 0 and 1 makes the good normal but a necessity, since purchases rise more slowly than income. Anything below 0 makes it inferior, since purchases fall as income rises. The two cutoffs are 0 and 1, so read the sign first and the size second.
Can a good be normal for one person and inferior for another?
A good can be normal for one buyer and inferior for another, because income elasticity is measured for a specific group over a specific income range. A student whose income doubles may buy more frozen pizza, while a household moving from a middle to a high income buys less of it. Neither result is a mistake; they are two separate measurements of two different sets of buyers.
How is income elasticity of demand different from price elasticity of demand?
Income elasticity of demand and price elasticity of demand share a numerator but not a denominator. Both put the percentage change in quantity demanded on top. Income elasticity divides by the percentage change in income, while price elasticity divides by the percentage change in the good's own price. Income elasticity sorts goods into normal and inferior, while price elasticity predicts how total revenue reacts when a firm changes its price.
Formula / Example
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Related terms
Common comparisons
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