Income Elasticity Of Demand

Income Elasticity of Demand

The income elasticity of demand measures the responsiveness of quantity demanded to changes in income. It is a measure of how much the quantity demanded of a good changes in response to a change in income.

Formula:

Income Elasticity of Demand (ε) = %ΔQd / %ΔI

where:

• ε is the income elasticity of demand
• ΔQd is the change in quantity demanded
• ΔI is the change in income

Interpretation:

• If ε is positive, the good is considered to be normal, meaning that the quantity demanded increases when income increases.
• If ε is negative, the good is considered to be inferior, meaning that the quantity demanded decreases when income increases.
• The absolute value of ε determines the magnitude of the change in quantity demanded in response to a change in income.

Causes of Income Elasticity of Demand:

• Availability of substitutes: If there are close substitutes for a good, consumers can afford to consume less of the good when income decreases.
• Relative price changes: If the price of a good increases relative to other goods, consumers may reduce their demand for that good.
• Changes in consumer preference: If consumers’ preferences change and they prefer other goods more, the demand for the original good may decrease.

Examples:

• A normal good, such as coffee, has an income elasticity of demand of 0.8. If income increases by 10%, the quantity of coffee consumed increases by 8%.
• An inferior good, such as rice, has an income elasticity of demand of -0.5. If income increases by 10%, the quantity of rice consumed decreases by 5%.

Applications:

• Income elasticity of demand is used to predict how changes in income will affect the demand for goods and services.
• It is also used to understand the impact of income on consumer behavior.

Additional Notes:

• The income elasticity of demand can vary across goods and services.
• The income elasticity of demand is a measure of responsiveness, not absolute change.
• The income elasticity of demand can be positive or negative, depending on the good in question.