Income Elasticity of Demand | Definition, Types, Factors, Example

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Tutorial Topics: What is Income elasticity of demand Definition, formula, example, Types, Factors of income elasticity of demand.

Similar to the price elasticity of demand, the income of consumers is also an important determinant of the demand for the product.


What is Income Elasticity of Demand?

An increase in the income of consumers increases the demand for the product even if the price remains constant. The responsiveness of quantity demanded with respect to the income of consumers is called the income elasticity of demand.


Income Elasticity of Demand Definition

The following are some important popular definitions of income elasticity of demand:

Income elasticity of demand means the ratio of the percentage change in the quantity demanded to the percentage in income.

Watson

The responsiveness of demand to change in income is termed as income elasticity of demand.

Richard G. Lipsey

Income Elasticity of Demand Formula

Mathematically, the income elasticity of demand can be stated as:

Income Elasticity of Demand Formula

Where,
Percentage change in quantity demanded =

Income Elasticity of Demand Formula 1

Percentage change in income =

Income Elasticity of Demand Formula 2

Thus, the formula for calculating the price elasticity of demand is as follows:

Where,
Q is original quantity demanded
Q1 is new quantity demanded
∆Q = Q1–Q
Y is original income
Y1 is new income
∆Y = Y1 – Y


Income Elasticity of Demand Example

Let us understand the concept of income elasticity of demand with the help of an example.

Example: Suppose the monthly income of an individual increases from 5,000 to 15,000. Now, his demand for clothes increases from 35 units to 70 units. Calculate the income elasticity of demand.

Solution: Given that:

Y = 5,000 Y1= 15,000
∆Y = 15,000-5,000 = 10,000
Q = 35 units
Q1 = 70 units
∆Q = 70 – 35 = 35

The formula for calculating the income elasticity of demand is:

Substituting the values,


Types of Income Elasticity of Demand

Similar to the types of price elasticity of demand, the degree of responsiveness of demand with a change in consumer’s income is not always the same.

The income elasticity of demand varies for different products and under different situations. On the basis of numerical value, types of income elasticity of demand is classified into three groups, which are explained as follows:

Positive income elasticity of demand

When a proportionate change in the income of a consumer increases the demand for a product and vice versa, income elasticity of demand is said to be positive. In case of normal goods, the income elasticity of demand is generally found positive, which is shown in Figure.

In Figure, DYDY is the curve representing positive income elasticity of demand. The curve is sloping upwards from left to the right, which shows an increase in demand (OQ to OQ1) as a result of rise in income (OB to OA).

Three types of positive income elasticity of demand

There are three types of positive income elasticity of demand, namely unitary income elasticity of demand, less than unitary income elasticity of demand, and more than income elasticity of demand. Let us discuss them as follows:

  • Unitary income elasticity of demand: The income elasticity of demand is said to be unitary when a proportionate change in a (increase) for a product. For example, if there is 25% increase in the income of a consumer, the demand for milk consumption would also be increased by 25%. Thus ey = 25/25 =1.

  • Less than unitary income elasticity of demand: The income elasticity of demand is said to be less than unitary when a proportionate change in a consumer’s income causes comparatively less increase in the demand for a product. For example, if there is an increase of 25% in consumer’s income, the demand for milk is increased by only 10%. Thus ey = 10/100 = 0.1 < 1.

  • More than unitary income elasticity of demand: The income elasticity of demand is said to be more than unitary when a proportionate change in a consumer’s income causes a comparatively large increase in the demand for a product. For example, if there is an increase of 25% in consumer’s income, the demand for milk is increased by only 35%. Thus ey = 35/25 = 1.4 > 1.

Negative income elasticity of demand

When a proportionate change in the income of consumer results in a fall in the demand for a product and vice versa, the income elasticity of demand is said to be positive. It generally happens in the case of inferior goods.

For example, consumers may prefer small cars with a limited income. However, with a rise in income, they may prefer using luxury cars.

Figure shows the negative income elasticity of demand

In Figure, DYDY is the curve representing negative income elasticity of demand. The curve is sloping downwards from left to the right, which shows a decrease in the demand as a result of a rise in income. As shown in Figure 5.14, with a rise in income from 10 to 30, the demand falls from 3 to 2.

Zero income elasticity of demand

When a proportionate change in the income of a consumer does not bring any change in the demand for a product, income elasticity of demand is said to be zero. It generally occurs for utility goods such as salt, kerosene, electricity. Figure 5.15 shows the zero income elasticity of demand:

In Figure, DYDY is the curve representing zero income elasticity of demand. The curve is parallel to Y-axis that shows no change in the demand as a result of a rise in income. As shown in Figure 5.14, with a rise of income from 10 to 20, the demand remains the same i.e. 4.


Factors Affecting Income Elasticity of Demand

As discussed earlier, the income elasticity of demand for a product reflects the change in the quantity demanded as a result of change in consumer’s income. However, the income elasticity differs for different products as it depends on various factors. Some of these factors are listed in Figure.

Let us discuss these factors in detail.

Income of consumers in a country

In any country, the income level of consumers is not the same. Therefore, consumers spend on the basis of not only on their need but also their purchasing capacity. The purchasing capacity of consumers increases with a rise in their income.

For example, a consumer with a low income may prefer using public transport for commuting. However, with a rise in income, he/she may buy a two-wheeler for the same purpose.

Nature of products

The nature of products being consumed by consumers also has an important influence on income elasticity.

For example, basic goods used on a day to day basis, such as salt, sugar, and cooking oil, is elastic. Even with a rise in the income of a consumer, the demand for such products does not change and remain inelastic.

Consumption pattern

With a rise in income, people quickly change their consumption patterns. For example, people may start buying high priced products with an increase in their income. This leads to an increase in the demand for the products in the market. However, once the consumption pattern is established, it becomes difficult to lower the demand in case of a decrease in income.

For example, a consumer may buy a two-wheeler that runs on petrol as a result of a rise in his/her income. However, over a period of time, in case his/her income falls, it will be difficult for him to reduce the consumption of petrol.


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