Income Elasticity of Demand and Types of Income Elasticity of Demand

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Elasticity of Demand

The elasticity of demand is a measure of degree of responsiveness of quantity demanded for a product to the change in its determinants.

The law of demand helps to understand the direction in which price and quantity demanded change.

It is limited to the statement as:

If price increases, quantity demanded will decline or if income rises demand will increase.

But it cannot answer by how much?

In business or economic analysis, it is essential to address ‘by how much’ question.

It is necessary to find out the exact value of the change in quantity demanded in response to the change in price or income.

Elasticity of demand helps to find out the exact values in such cases.

 

The elasticity of demand is a measure of degree of responsiveness of demand for a product to the change in its determinants.

Elasticity of demand (Ep) = Percentage change in quantity demand for a good ÷ Percentage change in its price

 

Demand is determined by various factors such as price, income, price of other goods, taste, preferences etc.

There are various types of elasticity of demand as its determinants.

However, we discuss only price, income and cross elasticity of demand as they are the main determinants of demand whose change is visible and measurable.

 

Types of Elasticity of Demand  

There are three types of elasticity of demand; they are:

Price elasticity of demand

Income elasticity of demand

Cross elasticity of demand

 

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Income Elasticity of Demand  

Income elasticity of demand is the measure of responsiveness of quantity demanded of a product to the change in income of a consumer.

Income of a consumer is the most important influencing factor of demand for a good and supply.

Demand for a good responses to the change in income of the buyer.

It measures the responsiveness of demand for particular goods to change in income of the buyer.

It shows the relationship between the percentage change in quantity demanded of a good for a given percentage change in income of the buyer.

It is defined as the percentage change in quantity demanded for a good divided by the percentage change in income of the buyer.

Income elasticity is usually symbolized by E_Y and written as:

The income elasticity of demand is a unit free measurement.

It is always expressed in terms of ratio or percentage.

The value of it may be positive, negative or zero depending on the nature of goods.

 

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Types of Income Elasticity of Demand

Income elasticity of demand can be classified into three categories; positive, negative and zero.

(1) Positive income elasticity of demand (E_Y > 0)

If percentage change in quantity demanded for a good is positive in response to the percentage change in income (other things remaining unchanged) of a buyer, then the demand is known as positive income elastic demand.

There will be positive relationship between income of a buyer and quantity demand for a good.

An increase in income leads to an increase in demand and vice versa.

Therefore, the value of income elasticity of demand remains positive.

 

 

 In the above figure, the income demand curve (D_X) is upward sloping against the income level of the buyer.

The M₁ and Q₁ are the original income and quantity demand respectively.

When income increases from M₁ to M₂, (by ΔM/M₁ percentage) then quantity demanded also increases from Q₁ to Q₂ (by ΔQ/Q₁ percentage).

Here both income and demand are changing in the same direction i.e. increasing so the value of income elasticity is positive.

This type of income elasticity can be found in luxurious goods like iPhone, Rolex watch, Ferrari car, Diamond etc.

  

 

Keep in Mind

Positive income elasticity of demand has three options

Unitary income elasticity of demand:

If income increases by 50% and demand also rises by 50%, then the demand would be called as unitary income elasticity of demand.

In such a case, the numerical value of income elasticity of demand is equal to one (ey = 1).

More than unitary income elasticity of demand:

If the income increases by 50% and demand rises by 100%.

In such a case, the numerical value of income elasticity of demand would be more than one (ey>1).

Less than unitary income elasticity of demand:

If the income increases by 50% and demand increases only by 25%.

In such a case, the numerical value of income elasticity of demand would be less than one (ey<1).

 

 

(2) Negative income elasticity of demand (W_Y < 0)

If proportionate change in quantity demanded of a good is negative in response to the proportionate change in income of the buyer, then the demand is known as negative income elastic of demand.

There is inverse relationship between change in income and demand.

An increase in income leads to a decline in quantity demanded and vice versa.

The income elasticity of demand is negative for inferior goods and Giffen goods.

For example, if the income of a consumer increases, he would prefer to purchase cashew nut instead of pea nut.

In such a case, the pea nut would be inferior to the customer.

 

  

In the above figure, the income demand curve (D_X) is downward sloping against the income level (M).

The M₁ and Q₁ are the original combination of income and quantity demanded.

As income increases from M₁ to M₂ then the quantity demanded decreases from Q₁ to Q₂.

Since change in income and change in quantity demanded is moving in opposite directions, the elasticity is negative.

This type of elasticity can be found in inferior goods.

 

(3) Zero income elasticity of demand (E_Y = 0)

If quantity demand for a good is totally irresponsive to the change in income of a buyer, then the demand is known as zero income elastic demand.

There is no relationship between change in income and demand.

In the case, quantity demanded remains constant for all levels of income and the value of elasticity remains zero.

The income elasticity of demand is zero in essential goods; salt is demanded in same quantity whether price is high or low.

 

 

In the above figure, the income demand curve is a vertical straight line as shown in figure.

The demand curve indicates the quantity demanded remains constant for all levels of income.

 

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