Income elasticity of Demand

The demand's sensitivity to changes in consumer income is demonstrated by the term "income elasticity of demand." The ratio of the percentage change in a commodity's demand to the percentage change in income is another definition for the term "income elasticity of demand."

Income elasticity is usually symbolized by 'Ey' and written as:

Ey = percentage change in quantity demand / percentage change in income of the consumer

= (ΔQ / ΔY) * (Y / Q)

where,

Ey = Income elasticity demand

ΔY= Change in consumer income

ΔQ= Change in quantity

Q = Quantity

Y = Income

For instance, if a consumer's income grows from $100 to $102, and his demand for good X rises from 25 to 30 units per week, his income elasticity of demand for item X is as follows:

Ey = 5/25 x 100/2 = 10

In other words, a 10% rise in demand causes a 1% increase in income, and vice versa.

Depending on the characteristics of a commodity, the income elasticity may be positive, negative, or zero. The income elasticity is positive because rising income results in rising demand. A normal good is a commodity with positive income elasticity. On the other hand, a commodity's income elasticity is negative when an increase in income results in a decline in demand for it. Such a product is referred to as an inferior good. The income elasticity of demand is zero if the amount of a good is purchased regardless of changes in income.

Types of Goods

• Inferior goods: When demand for a good diminishes or reduces gradually as income levels or real GDP in the economy rise or rise, it is said to be an inferior good. When a good has more expensive alternatives, this happens. The opposite of a normal good, which experiences rising demand and rising income levels, is an inferior good. Public transportation is an illustration of a substandard good. When consumers are less wealthy, they might decide against using their own private vehicles in order to save money (on things like gas, insurance, and other car maintenance) and instead opt to use a less expensive mode of transportation.
• Superior goods: A superior good, on the other hand, is one for which demand progressively rises as income levels or real GDP in the economy improve or rise. A better good is a regular good. a prime example of a premium product in the automobile industry.

Types of Income Elasticity of Demand

Following are the five categories of income elasticity of demand:

• Positive income elasticity of demand (Ey=+ve): Positive income elasticity occurs when the quantity demand for a commodity rises as consumer income rises and falls as consumer income falls. The relationship between income and demand is hence positive. The value of elasticity is still more than zero in the scenario. It has three degrees or values which are described below:

  • Income elasticity greater than unity (Ey>1): Demand is considered to be income elastic if the percentage change in quantity demand is greater than the percentage change in income. When demand for a commodity increases more than a percentage increase in income, the income elasticity of demand is greater than unity. Its value in numbers is higher than 1.

  • Income elasticity less than unity (Ey< 1):  Demand is considered to be income inelastic if the percentage change in quantity demand is less than the percentage change in income. When demand for a good or service increases less than proportionately to an increase in income, the income elasticity of demand is less than unity. Its value in numbers is less than 1..

  • Income elasticity equal to unity (Ey=1): Demand is referred to as unitary income elastic if the percentage change in quantity demand is equal to the percentage change in consumer income. When a commodity's demand grows in the same manner that income does, the income elasticity is unity. It has a numerical value of 1.

• Zero income elasticity (Ey=0): Income elasticity is referred to as zero income elasticity if, notwithstanding an increase in income, the quantity demanded does not change. It has a relationship with neutral items. In other terms, a good is said to have zero income elasticity of demand if the quantity demand is completely unresponsive to a consumer's change in income. Demand and income fluctuation have no correlation. In that situation, demand is constant across all income levels, and the elasticity value is 0.

• Negative income elasticity (Ey< 0): It is known as the negative elasticity of demand if a commodity's quantity demand rises with consumer income grows and falls with consumer income lowers. As a result, there is a negative correlation between consumer income and quantity demand. The value of elasticity would then still be less than zero.

Determinants of Income Elasticity of Demand

Following are the primary factors that affect demand elasticity according to income:

• Due to the commodity's inherent status as a necessity, the proportion of income spent on food drops as income does.
• The people's degree of income also affects the income elasticity. For example, a TV set is a luxury in an underdeveloped poor country while it is a ‘necessity’ in a country with high per capita income.
• The temporal frame, as changes in income have a lag on purchasing patterns.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan