2.21:
Income Elasticity of Demand
Income elasticity of demand measures how much people change their buying habits when their income changes.
It is quantified as the percentage change in the quantity demanded of a good divided by the percentage change in income.
It helps to classify goods into different groups. First, there are inferior goods. These have a negative income elasticity.
An example is cheap instant noodles. As people earn more, they often upgrade to higher-quality food.
Then there are normal goods. They have an income elasticity value greater than zero but less than one. With increased earnings, individuals often elevate their lifestyle, such as transitioning from a basic phone to a more advanced smartphone.
Lastly, there are luxury goods. These have an income elasticity value greater than one.
An example is an individual upgrading from an ordinary car to a fancy sports car when they have a lot of money to spend.
This concept helps businesses predict sales under different economic conditions.
Additionally, it assists governments in understanding the effect of income tax changes on consumer spending patterns in the economy.
2.21 Income Elasticity of Demand
Income elasticity of demand quantifies how the quantity demanded of a good responds to changes in consumer income. It is calculated as the ratio of the percentage change in quantity demanded to the percentage change in income.
Classification of Goods:
- • Inferior Goods: These goods exhibit a negative income elasticity. As individuals' income increases, their consumption of these goods decreases. For instance, as a person's financial situation improves, they might prefer dining at restaurants over purchasing instant noodles.
- • Normal Goods: These goods exhibit a positive income elasticity. The demand for normal goods increases as consumer income rises. A typical example involves upgrading from public transportation to owning a personal vehicle for daily commuting.
- • Luxury Goods: These goods have an income elasticity greater than one, indicating that demand increases more than proportionately as income rises. Imagine someone choosing to buy designer clothing instead of generic brands as their disposable income increases.
Understanding income elasticity helps businesses forecast demand under varying economic scenarios and aids governments in assessing how fiscal policies, like tax adjustments, might affect consumer expenditure.