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Income Elasticity of Demand Income elasticity of demand measures the relationship between a change in quanti ty demanded and a change

in income. The basic formula for calculating the coeffi cient of income elasticity is: Percentage change in quantity demanded of good X divided by the percentage chang e in real consumers' income Normal Goods Normal goods have a positive income elasticity of demand so as income rise more is demand at each price level. We make a distinction between normal necessities and normal luxuries (both have a positive coefficient of income elasticity). -INTERNATIONAL AIR TRAVEL -FINE WINE -LUXURY CHOCLATE -PRIVATE EDUCATION -PRIVATE HEALTHCARE -ANTIQUE FURNITURE -DESIGNER CLOTHES Necessities have an income elasticity of demand of between 0 and +1. Demand rise s with income, but less than proportionately. Often this is because we have a li mited need to consume additional quantities of necessary goods as our real livin g standards rise. The class examples of this would be the demand for fresh veget ables, toothpaste and newspapers. Demand is not very sensitive at all to fluctua tions in income in this sense total market demand is relatively stable following changes in the wider economic (business) cycle. -FRESH VEGETABLES -INSTANT COFFEE -NATURAL CHEESE -FRUIT JUICE -LOCAL UTILITIES -SHAMPOO/ TOOTHPASTE/ DETERGENT -RAIL TRAVEL Luxuries on the other hand are said to have an income elasticity of demand > +1. (Demand rises more than proportionate to a change in income). Luxuries are item s we can (and often do) manage to do without during periods of below average inc ome and falling consumer confidence. When incomes are rising strongly and consum ers have the confidence to go ahead with big-ticket items of spending, so the dema nd for luxury goods will grow. Conversely in a recession or economic slowdown, t hese items of discretionary spending might be the first victims of decisions by consumers to rein in their spending and rebuild savings and household financial balance sheets. Many luxury goods also deserve the sobriquet of positional goods . These are produc ts where the consumer derives satisfaction (and utility) not just from consuming the good or service itself, but also from being seen to be a consumer by others . Inferior Goods Inferior goods have a negative income elasticity of demand. Demand falls as inco me rises. In a recession the demand for inferior products might actually grow (d epending on the severity of any change in income and also the absolute co-effici ent of income elasticity of demand). For example if we find that the income elas ticity of demand for cigarettes is -0.3, then a 5% fall in the average real inco mes of consumers might lead to a 1.5% fall in the total demand for cigarettes (c eteris paribus). -FROZEN VEGETABLE -CIGARETTES -PROCESSED CHEESE -MARGARINE -TINNED MEAT

-LOCAL BREAD -BUS TRAVEL Within a given market, the income elasticity of demand for various products can vary and of course the perception of a product must differ from consumer to cons umer. The hugely important market for overseas holidays is a great example to de velop further in this respect. What to some people is a necessity might be a luxury to others. For many product s, the final income elasticity of demand might be close to zero, in other words there is a very weak link at best between fluctuations in income and spending de cisions. In this case the real income effect arising from a fall in prices is like ly to be relatively small. Most of the impact on demand following a change in pr ice will be due to changes in the relative prices of substitute goods and servic es.

The income elasticity of demand for a product will also change over time the vas t majority of products have a finite life-cycle. Consumer perceptions of the val ue and desirability of a good or service will be influenced not just by their ow n experiences of consuming it (and the feedback from other purchasers) but also the appearance of new products onto the market. Consider the income elasticity o f demand for flat-screen colour televisions as the market for plasma screens dev elops and the income elasticity of demand for TV services provided through satel lite dishes set against the growing availability and falling cost (in nominal an d real terms) and integrated digital televisions.