Income elasticity of Demand Managerial Economics

INCOME ELASTICITY OF DEMAND

The income elasticity of demand is defined as the rate of change in the quantity demanded of a good due to changes in the income of the consumer.

It is the responsiveness of demand to the change in income

It is calculated as the percentage change in demand to the percentage change in income

INCOME ELASTICITY OF DEMAND

It measures the relationship between a change in quantity demanded and a change in income.

The basic formula for calculating the of income elasticity is:

Percentage change in demand Percentage change in income

If, in response to a 10% increase in income, the demand for a good increased by 20%, the income elasticity of demand would be 20%/10% = 2.

When a buyer in a certain income range experiences an income increase, their purchase of a product changes to match that of individuals in their new income range.

EXAMPLE

1) If the proportion of income spent on the goods remains the same as the income increases ,then the income elasticity of demand for the goods is equal to one.

2) If the proportion of income spent on goods increases as income increases , then the income elasticity of demand is more than one.

Relationship between income elasticity for goods and the proportion of income spent on it

3) If the proportion of income spent on goods decreases as income increases , then the income elasticity for the goods is less than one.

4)If the change in income will have no effect on the quantity demanded , then it is negative income elasticity.

NORMAL GOODS Normal goods have a positive income

elasticity of demand so as income rise more is demand at each price level.

Normal goods are of two:-Normal Necessities and Normal Luxuries (both have a positive coefficient of income elasticity).

Necessities have an income elasticity of demand of between 0 and +1. Demand rises with income. If the income elasticity is less than one, it is called a necessity.

Luxuries on the other hand are said to have an income elasticity of demand more than +1. (Demand rises more than proportionate to a change in income).

If the income elasticity of good is greater than one, it is called luxury.

INFERIOR GOODS Inferior goods have a negative income

elasticity .Demand falls as income rises.

Examples of Normal and Inferior goods.

Negative income elasticity : If the demand for a commodity

decreases with an increases in income, the demand is said to be negative income elastic. The income elasticity co-efficient in this case is Ed<0

Eg: Jowar, Bajra etc

TYPES OF INCOME ELASTICITY

Zero income elasticity When the change in income do not

bring about any changes in quantity demanded, that is quantity demanded remains same, it is said to be zero income elasticity. Income elasticity co-efficient is

Ed = 0Eg : Salt, Matches

Income elasticity less than one When the percentage change in

quantity demanded is less than percentage changes in income , the income elasticity is said to be less than one. Thus income elasticity co-efficient is Ed <1

Eg : Food grains

Income elasticity equal to one If the percentage change in quantity

demanded is equal to percentage change in income, it said to be unitary income elastic. Income elasticity co-efficient is Ed =1

Eg : Fruits , Vegetables.

Income elasticity greater than one The percentage change in quantity

demanded is greater than the percentage change in income, the income elasticity is said to be greater than one. The income elasticity co-efficient is Ed > 1

Eg : TV sets, Cars.

Quantity of a commodity demanded

ab c

d

e

X

Y

INCOME

a : Ed <0b : Ed =0c : Ed < 1d : Ed = 1e : Ed > 1

NATURE OF GOODS TYPES OF ELASTICITY

EXAMPLES

NORMAL GOODS POSITIVE FRUITS

INFERIOR NEGATIVE JOWAR

LUXURY POSITVE, GREATER THAN 1

TV SETS

ESSENTIAL POSITIVE,LESS THAN 1

FOOD GRAINS

NEUTRAL ZERO SALT