Income elasticity of demand: Definition, Formula, Examples

Income elasticity of demand

The income elasticity of demand measures the percentage change in the quantity that is acquired of a good during a given period as a consequence of a percentage change in the consumer’s income. It is one of the aspects measured by the law of demand.

If the consumer’s income changes, there will be a change in demand, as income increases, the demand for certain goods will increase and that of others will fall.

There will be goods that he or she will acquire in greater quantity, there are others that he or she will stop buying and others whose consumption will increase dramatically.

Formula for calculating the income elasticity of demand

First, the variation in demand and income is calculated (The higher number minus the lower number). Then the two results are divided. There is an example with the procedure below.

How to interpret the income elasticity of demand

The variation in the demand for goods is indicated by the income elasticity coefficient of demand, which is a quantity that can be greater than or less than 1.

Depending on what happens to the demand of these goods because of the variation of income (percentage change), a classification of them has been created.

• The good is a luxury good if the coefficient is greater than 1.
• The good is normal good if the coefficient is greater than 0.
• The good is inferior good if the coefficient is inferior to 0.

Types of goods

Goods can be normal, inferior, and luxury.

Normal goods

Normal goods are those whose demand increases as the consumer’s income increases, it usually happens with the products of the basic basket, such as meat, pasta and butter, which are goods that, regardless of income, are always consumed. The good is normal when the coefficient is greater than 0.

Inferior goods

The inferior goods are those whose demand decreases with increasing income. For example, if a consumer has a higher income, he bought sardines before and now that he generates more money, he will no longer buy sardines, but will buy something that better satisfies his diet and preferences.

Sardines may be an inferior good because as your income increases, you will no longer want to consume them so frequently. The good is inferior if the coefficient of elasticity is less than 0.

Luxury goods

When we are in the presence of luxury goods, the consumer demands them more with as the income is higher. In more specific terms, a luxury good is one whose income elasticity of demand is greater than 1.

Example with a solved exercise of the income elasticity of demand

Exercise

Given the following table with the quantities demanded by a unit of consumption per year at different income levels:

Determine:

The income elasticity of demand for this consumption unit for the different income levels.

Solution

Interpretation

Column 𝑒𝑀 is the income elasticity of demand for its different income levels.

The column “Type of good” indicates that up to the income level of $. 13,650, the good is a luxury, since 𝑒𝑀> 1. For income levels above $13,650 up to $. 17,550 the good is normal (𝑒𝑀> 0). Above $17,550 the good is inferior (𝑒𝑀 <0).

How to Calculate Income Elasticity – Procedure

Above, you could see an exercise of income elasticity already solved, now we proceed to explain how it was solved.

Formula: