Income Elasticity of Demand

Income Elasticity of Demand

The income elasticity measures the responsiveness in quantity demanded to the change in income. In other words, it measures by how much the quantity demanded changes with change in income. The income elasticity of demand is defined to be the percentage change in quantity demanded resulting from a 1 percent change in consumer’s income.

According to C. E. Ferguson, “Income elasticity of demand is the proportionate change in quantity demanded divided by proportionate change in income.”

The formula to measure income elasticity is,

Income elasticity = Proportionate change in quantity demanded/Proportionate change in income

Ey = Δq/Δy  x   y/q

Where, y denotes income

The concept of elasticity of income can be illustrated by the help of an example. Suppose that when the income is $100, demand is 25 units. Now suppose that the income increase to $150. As a result of its demand increases to 30 units. The elasticity of income is calculated as,

EyΔq/Δy  x   y/
= 5/50 x 100/25 = 2/5

The coefficient 2/5 shows that the demand is inelastic.

Types of Income Elasticity

There are three types of income elasticity in practice. They are:

1. Positive income elasticity (Ey > 0)
If the demand for the commodity increases with increase in income elasticity is said to be positive. For most commodities increase in income lead to increases in quantity demanded. Such goods are called normal goods. Normal goods have positive income elasticities.

2. Negative Income Elasticity (Ey < 0)
If the demand decreases in income, income elasticity is said to be negative. Inferior goods such as cheap foods have negative income elasticities.

3. Zero Income Elasticity (Ey = 0)
The boundary between positive and negative income elasticity is zero income elasticity. If the demand for the commodity does not change with the increase in income, income elasticity is said to be zero. This happens in case of neutral goods such as salt, matches etc.

These three types of income elasticity have been shown in a single diagram below:
Types of Income Elasticity
In the figure, demand curves show zero, positive and negative income elasticity. Good A has zero income elasticity. Good B is a normal good with a positive income elasticity. Good C is an inferior good with a negative income elasticity.

It should, however, be noticed that a good does not have to be in the same category at all levels of income. The same good may have zero income elasticity at very low level of income; positive elasticity at higher level of income and negative income elasticity at very high level of income.
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