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Income Elasticity

# Income Elasticity

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11/16/2013

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Income elasticity of demand
(Redirected fromIncome elasticity of demand (YED)

incomeelasticityof demand
measures the responsiveness of the demand for agood to a change in the income of the people demanding the good. It is calculated as the ratio of the percentage change in demand to the percentage change in income. For example, if, inresponse to a 10% increase in income, the demand for a good increased by 20%, the incomeelasticity of demand would be 20%/10% = 2.
Interpretation
Inferior goods' demand falls as consumer income increases.
y

A
negative income elasticity of demand is associated withinferior goods; an increase inincome will lead to a fall in the demand and may lead to changes to more luxurioussubstitutes.
y

A
positive income elasticity of demand is associated withnormal goods; an increase inincome will lead to a rise in demand. If income elasticity of demand of a commodity isless than 1, it is a necessity good. If the elasticity of demand is greater than 1, it is aluxury goodor asuperior good.
y

A
zero income elasticity (or inelastic) demand occurs when an increase in income is notassociated with a change in the demand of a good. These would bestickygoods.Income elasticity of demand can be used as an indicator of industry health, future consumption patterns and as a guide to firms investment decisions. For example, the "selected incomeelasticities" below suggest that an increasing portion of consumer's budgets will be devoted to purchasing automobiles and restaurant meals and a smaller share to tobacco and margarine.
[1]

M
athematical definition

M
ore formally, the income elasticity of demand, , for a given
M
arshallian demand function for a good isor alternatively:This can be rewritten in the form:With income
I
, and vector of prices .
M
anynecessitieshave an income elasticity of demand between zero and one: expenditure on these goods may increase with income, but not as fast asincome does, so the proportion of expenditure on these goods falls as income rises. Thisobservation for food is known as
Engel's law
.
Income Elasticity Of Demand

Wh
at Does
Income Elasticity Of Demand
Mean?
A measure of the relationship between a change in income and a change in quantity of a gooddemanded:
Investopedia explains
Income Elasticity Of Demand
The degree to which a demand for a good changes with respect to a change in income depends on

whether the good is a necessity or a luxury. The demand for necessities will increase with income, but ata slower rate. This is because consumers, instead of buying more of only the necessity, will want to usetheir increased income to buy more of a luxury. During a period of increasing income, demand for luxuryproducts tends to increase at a higher rate than the demand for necessities.
E
lasticity
Elasticity
refers to the
responsiveness
of demand or supply to changes in price or income. The usualmeaning is the
price elasticity of demand
, or the responsiveness of the quantity demanded to price. Wespeak of an
elastic
demand -- one which is very responsive to price, and which would result in arelatively
flat
demand curve; and of an
inelastic
demand -- one
not
very responsive to price.
The language is a bit awkward. When we say
inelastic
, we mean the responsiveness is
small
notnon-existent. The terminology
perfectly inelastic
is sometimes used for a demand which is notat all responsive to price.The
coefficient of elasticity
or
CO
E
for short is the measure of elasticity.It is defined as the
percentage change in the quantity demanded
divided by the
percentagechange in price
1
.

It is in terms of
percentage
changes, not just "changes". An increase of a dollar is a bigpercentage change for a newspaper, and will lose them many customers; a dollar increase in theprice of a car will not lose many buyers -- yet the newspaper and car demand curves could havethe same elasticity. Percentage change calculations are further discussed in the link on the midpoint formula.2.

There is a close connection between the elasticity of demand and the
revenue
change resultingfrom a price change. If the COE is greater than
1
, it means the percentage change in quantity is
greater than
the percentage change in price. For example, if the COE is 3, a
10
percent increasein price will lead to a ____ percent decrease in quantity demanded, or to a ____ loss in revenue.(If you can't fill in the blanks, click here for a discussion of percentage change algebra
Extended elasticity concepts
As well as the
price elasticity of demand
-- by far the most frequently used elasticity concept -- we canalso speak of:
1
.

the
income elasticity of demand
defined as the percentage change in quantity demanded divided by the percentage change in