Income Elasticity of Demand- Meaning, Types, Formula

Income elasticity of demand is described as the elasticity of demand driven by differences in consumer income. Read this blog to discover more!

The income elasticity of demand defines the relationship between the wages of a consumer and the demand for a certain product. It could be positive or negative, or even non-responsive to a given product. In contrast to the price-demand equation, consumer income and product demand are deeply interwoven.

Income Elasticity of Demand Meaning

The sensitivity of the quantity required for a specific item to a change in the real income of customers who purchase that good is referred to as income elasticity of demand.

The formula for measuring income elasticity of demand is the percentage change in the amount demanded divided by the percentage change in income. With income elasticity of demand, one can determine if a certain commodity is a need or a luxury.

Income Elasticity of Demand Formula

The formula for income elasticity of demand is calculated by dividing the percentage change in quantity demanded by the percentage change in income. Mathematically, it can be expressed as follows:

Income Elasticity of Demand (YED) = Percentage Change in Quantity Demanded / Percentage Change in Income

Types of Income Elasticity of Demand

There are several types of income elasticity of demand that help economists and businesses understand consumer behavior. Here are the main types:

Positive Income Elasticity (Luxury Goods):

When the demand for a good increases as consumer income rises, it is termed as positive income elasticity. For example, luxury things like pricey automobiles or fashionable apparel often fall within this category. As people's income rises, they tend to purchase more of these things, demonstrating a positive link between income and demand.

Negative Income Elasticity (Inferior Goods):

Conversely, negative income elasticity occurs when the demand for a good decreases as consumer income rises. Inferior goods, such as low-quality or generic products, often exhibit this characteristic. When people's incomes increase, they may shift from inferior goods to higher-quality alternatives, causing a decrease in demand for the inferior products.

Income Inelasticity (Necessities):

When the demand for a good remains relatively stable regardless of changes in income, it is known as income inelasticity. Necessities like basic food items or utilities often have an inelastic response to income changes. Even if consumers' incomes rise or fall, the demand for these goods remains relatively constant because they are essential for daily life.

Unitary Income Elasticity:

Unitary income elasticity occurs when the percentage change in quantity demanded is exactly equal to the percentage change in income. In this case, the total expenditure on the good remains constant as income changes. Goods with unitary income elasticity maintain a constant share of consumers' budgets, regardless of income fluctuations.

Zero Income Elasticity (Constant Income):

Zero income elasticity suggests that the quantity demanded for a good does not change in response to changes in income. Goods with zero income elasticity, often referred to as constant income goods, are typically non-essential items or specialty products. Regardless of how incomes fluctuate, consumers do not alter their demand for these goods.

Income Elasticity of Demand for Normal Goods

Normal goods are products for which demand increases as consumer incomes rise. In the context of Income Elasticity of Demand (YED), normal goods have a positive value of YED. For example, when individuals earn more, they tend to buy more high-quality clothing or better quality food items

Income Elasticity of Demand for Luxury Goods

Luxury goods represent products that people buy more of as their incomes increase significantly. In the context of YED, luxury goods have a YED value greater than 1, indicating a highly positive elasticity. Luxury goods, such as high-end cars, designer fashion, or luxury vacations, often exhibit YED values considerably higher than 1.

Income Elasticity of Demand for Inferior Goods

Inferior goods have a negative YED, indicating demand decreases as income rises. These goods include lower-quality products that consumers buy less of when their income increases. Examples include generic brands and basic public transportation services.

Income Elasticity of Demand Example

Imagine more people in a town getting better jobs and earning more money. Now, they can afford fancy iPhones and Samsung Galaxy phones. As their incomes rise, they buy these expensive phones because they want the best. This shows that when people earn more, they're willing to spend on these brands, making these phones popular among wealthier buyers. Apple and Samsung make sure to sell these phones to people with higher incomes by advertising their features and style.