Income Elasticity of Demand

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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:

1. If the proportion of income spent on goods remains the same as income increases, then income elasticity for the goods is equal to one.
2. If the proportion of income spent on goods increases as income increases, then the income elasticity for the goods is greater than one.
3. 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