Income Elasticity of Demand Meaning, Formula and Example

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Income Elasticity of Demand is a concept that shows light on how consumer preferences change with change in income of customers.

Definition of Income Elasticity of Demand

Income Elasticity of Demand (IED) is an important economic indicator that measures the responsiveness of consumer demand for a product to changes in income levels. 

In simple terms, it helps us to understand how sensitive the quantity demanded of a product is to changes in people’s incomes.

So student i think you have a question in your mind that why we study this topic is it really important or not?

Yes, Elasticity of Demand is an important topic to understand these points in economics:

  1. International trade
  2. Taxation Policy
  3. Factor Pricing
  4. Price Determination
  5. Penalty in the mix of Poverty

Formula for Calculating Elasticity of Demand

Basically, there are 4 Methods for Measurement of Elasticity Demand:

we can measure the elasticity of demand with the help of Graphical and algebraic Formula

  1. Percentage Method
  2. Point Method
  3. Arc Method
  4. Expenditure Method

Percentage Method

To calculate Income Elasticity of Demand, we use the following formula:

IED = (% change in quantity demanded) / (% change in income)

Now, don’t get intimidated by the formula; it’s not as scary as it looks! Let’s break it down with an example to make it crystal clear.

Let’s assume that the quantity demanded of smartphones increased by 8% when the average income of Daksh by 10%. To calculate IED for smartphones, we would use the formula:

IED = (8% / 10%) = 0.8

Interpretation of Income Elasticity of Demand:

IED values help us classify goods into specific categories based on consumer behavior and income changes.

Point Method

Prof. Marshall said that Point method is Divide using the Geometric calculation, we take into the consideration of demand curve and on that basis we calculate the degree

point method

Point Method = Lower Segments / Upper Segments

Above formula will help you to understand the various degree of price elasticity of demand curve is separated into upper part and lower part i.e., a point N is consider as separation point when we divide the upper segments with the lower Segments. We drive degree shown in the above graph.

Arc Method

It is also called as the arc elasticity where price change are calculated with particularly the Delta sign in Demand we use demand curve as Arc.

So the shrink & stretch in arc of notify as delta Q

Represent in the 2 variable

  1. Price of Commodity
  2. Quantity Demanded

Expenditure Method

This method is also known as the total reserve methos or total outlay method. it is calculated on the basis of total quantity sold.

TR = P X Quantity Sold

Types of Goods Based on Income Elasticity of Demand

Normal Goods

Assume that You get a raise at work, and suddenly you decide to treat yourself to a brand-new smartphone or a fancy pair of shoes. Well, that’s the magic of normal goods! These goods exhibit a positive relationship between income and demand. As people’s incomes rise, they tend to spend more on normal goods. Think of them as your favorite indulgences when you’re feeling a little extra fancy.

  • IED is positive and greater than 1.
  • Demand rises proportionately more than the increase in income.

Example: Premium smartphones, international vacations.

Income Elasticity of Demand

Necessary Goods

Now, we come to the essentials of life – Necessary goods! These are the things you simply can’t live without, regardless of whether you’re rolling in cash or watching your pennies. The demand for necessary goods increases with growing income, but not at the same rapid pace as normal goods. Think of items like basic groceries, medications, and utilities that you can’t go without even when money is tight.

  • IED is positive, but less than 1.
  • Demand increases, but at a slower pace than the income rise.

Example: Basic groceries, utilities.

Luxury Goods

Luxury goods are the true darlings of high-income individuals. As income levels soar, demand for these extravagant delights rises significantly. These could be designer clothing, high-end sports cars, or dreamy vacations to exotic destinations. 

  • IED is positive and significantly greater than 1.
  • Demand experiences substantial growth with relatively small income increments.

Example: Designer clothing, high-end cars.

Inferior Goods

Now, let’s meet the rebels – Inferior goods! These goods buck the trend and show a negative relationship between income and demand. You might be wondering, “Why on earth would people buy less of something as they earn more?” Well, it’s all about choices and preferences. When incomes rise, people may opt for better alternatives, leaving these goods behind. Think of used or lower-quality products that become less appealing when you can afford something better.

  • IED is negative.
  • Demand decreases as income rises.

Example: Low-quality goods, second-hand items.

Factors Affecting Income Elasticity of Demand:

Several factors influence IED, shaping consumer behavior in response to changing incomes.

Price of the good

If a good has a lower price, consumers may buy more of it, even with minor income fluctuations.

Availability of substitutes

When substitutes are readily available, consumers may switch to cheaper options during income decreases.

Nature of the good

Some goods are essential, irrespective of income levels (necessity goods), while others are more sensitive to income changes (luxury goods).

Number of usages

if a product is used for the multiple ways then there is a less elasticity to a price change. However id a commodity is not used for the different purposes and if it is used only once then it will be greater than one.

Time Period

it represent the consumption length for a particular commodity because commodity like soft drinks, biscuits are preferred in a short run, whereas electronic goods prefer in long run. So, it is important to note how the elasticity influence time aspect during consumption.

Habit

Consumer who are habitual to the certain brands will always prefers to buy the same commodity irrespective to the price change. However thee are certain brands that are always demanded irrespective of price changes.

My Perspective 

Understanding Income Elasticity of Demand is essential for businesses and policymakers alike. By analyzing consumer responses to income changes, companies can tailor their marketing strategies and product offerings effectively. 

Remember, embracing concepts like Income Elasticity of Demand can be a game-changer, much like how referral marketing has revolutionized the way startups grow.

If you want your business to grow and make a heavy impact on the market, so just dive into the world of economics with a curious mind and a passion for understanding consumer behavior.

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