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1.1.1 Income Elasticity of Demand
Income elasticity of demand is the degree of responsiveness of quantity demanded of goods to a small change in the income of consumers.
Formula = % change in quantity / % change in income
For income elasticity we keep the sign as we are interested in knowing whether income elasticity is negative or positive.
There is a useful relationship between income elasticity for a goods and proportion of income spent on it. The relationship between the two is described in the following three propositions:
- If the proportion of income spent on goods remains the same as income increases, then income elasticity for the goods is equal to one.
- If the proportion of income spent on goods increases as income increases, then the income elasticity for the goods is greater than one.
- If the proportion of income spent on goods decreases as income rises, then income elasticity for the goods is less than one.
Inferior Goods – Demand for inferior goods (low quality) decrease with increase in income. Negative income elasticity
Luxury Goods – Demand for luxury goods increase with increase in income. Positive income elasticity