INCOME ELASTICITY OF DEMAND

The demand for a good will change if consumers' incomes change, income
elasticity of demand measures that change. If the demand for housing were to
increase by 20% in response to a 5% increase in income, the income
elasticity of demand would be positive and relatively high.


If the demand for corned beef fell by 8% in response to the 5% increase in
income, then income elasticity of demand would be negative and relatively
small.


If the demand for food remained unchanged in response to an increase in
income, then the income elasticity of demand would be zero.


It is important to note that the distinction between income elasticity of demand
and price elasticity of demand here. Whether income elasticity has a positive
or negative sign is of vital importance. A positive income elasticity of demand
means that an increase in income will lead to an increase in demand for the
good in question. Conversely a negative income elasticity of demand means
that an increase in income will lead to a fall in demand for the good in
question.

The formula for measuring income elasticity of demand is:

%percentage change in quantity demanded/%percentage change in income  

(Not quite QPR, but Q is still on the top!)

Some simple calculations are shown below.

VALUES OF INCOME ELASTICITY

•  Income elastic demand - a good or service has an income elastic 

demand if income elasticity is greater than 1. A 1% change in income 

causes a greater than 1% change in quantity demanded. These are 

called luxury goods, e.g. foreign holidays.

•  Income inelastic demand - the value of income elasticity is between 0 

and 1. A 1% change in incomes causes a less than 1% change in 

quantity demanded. As the quantity demanded doesn't change a great 

deal in response to income we can assume the good is a necessity, 

e.g., food and clothes.

•  Negative income elasticity - in this case a change in income will bring 

about an opposite change in quantity demanded. If income goes up the 

quantity demanded will go down. The good is described as inferior, 

e.g., happy shopper bread.

Different income elasticities of demand are shown in the table below: