What is Income Elasticity of Demand
Income elasticity of demand refers to the change in demand that is affected by the changes in income. The income elasticity of demand shows the number that reflects how much the customer’s income affects the demand for a product.
This will show how many percentages of demand for a product will be increased if the customer income increase by X%. An increase in income generally increases the consumption of almost all goods, but maybe increases with a higher proportion for some goods.
However, the income elasticity of demand for most goods is different in the short term than in the long term. This is because the short-run decisions may be influenced by many factors other than income.
The income elasticity of demand can be calculated by dividing the percentage change in demand by the percentage change in income, or the following formula:
Income elasticity of demand = Percentage change in demand ÷ Percentage change in income
For example, when your income increases by 40% and your demand for product A increased by 20%.
So, the income elasticity of demand of a product A = 20 ÷ 40 = 0.5
Types of Income Elasticity of Demand
Normally, the value of income elasticity of demand can define the 4 types of goods in economics, which include:
- Normal good: A good whose consumption increases when an income increases (Income elasticity is positive).
- Necessity good: A good that increases demand by a smaller proportion than the increase in income (Income elasticity < 1).
- Luxury good: A good that demand increases by a greater proportion than the increase in income (Income elasticity > 1).
- Inferior good: A good that consumption decreases when income increases. (Income elasticity is negative).
From the example above, product A might be a necessity good that has income elasticity between 0 and 1. An increased income rises a customer’s consumption for a smaller proportion.