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Income Elasticity Of Demand

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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 (ฮต) = %ฮ”Qd / %ฮ”I

where:

  • ฮต is the income elasticity of demand
  • ฮ”Qd is the change in quantity demanded
  • ฮ”I is the change in income

Interpretation:

  • If ฮต is positive, the good is considered to be normal, meaning that the quantity demanded increases when income increases.
  • If ฮต is negative, the good is considered to be inferior, meaning that the quantity demanded decreases when income increases.
  • The absolute value of ฮต 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.

FAQs

  1. What is income elasticity of demand?

    Income elasticity of demand (YED) measures how the quantity demanded of a good changes as consumer income changes.

  2. What does it mean if income elasticity is less than 1?

    If YED is less than 1, the good is a necessity, and demand increases less proportionally to income.

  3. What does a YED of 1.5 mean?

    A YED of 1.5 means the good is a luxury, and demand increases by 1.5% for every 1% rise in income.

  4. What is positive and negative income elasticity of demand?

    Positive YED indicates normal goods (demand rises with income), while negative YED indicates inferior goods (demand falls as income rises).

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