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What is Income Elasticity of Demand?
Income elasticity of demand measures how the quantity demanded of a good or service responds to changes in consumer income. It helps economists and businesses understand whether a product is a necessity, luxury, or inferior good.
Definition
Income elasticity of demand is the percentage change in quantity demanded divided by the percentage change in income.
Key Takeaways
- Indicates how demand changes as income rises or falls.
- Helps classify goods as normal, inferior, or luxury.
- Important for forecasting demand and pricing strategy.
Understanding Income Elasticity of Demand
Income elasticity of demand (YED) shows the sensitivity of consumer demand to income changes. When incomes rise, demand for some goods increases significantly, while demand for others may increase slightly or even decline.
A positive income elasticity indicates a normal good, while a negative elasticity indicates an inferior good. Higher positive values usually signal luxury goods.
Businesses use this measure to anticipate demand shifts during economic growth or recession and to plan production, marketing, and pricing strategies accordingly.
Formula (If Applicable)
Income Elasticity of Demand = (% Change in Quantity Demanded) / (% Change in Income)
Real-World Example
If consumer income increases by 10% and demand for luxury cars rises by 20%, the income elasticity of demand is 2. This indicates a luxury good.
Importance in Business or Economics
Income elasticity of demand is important because it:
- Guides product positioning and targeting
- Supports economic and market forecasting
- Helps businesses adapt to income-driven demand changes
- Informs public policy and taxation decisions
Types or Variations
- Positive Income Elasticity — Normal and luxury goods
- Negative Income Elasticity — Inferior goods
- Zero Income Elasticity — Demand unaffected by income
Related Terms
- Price Elasticity of Demand
- Normal Goods
- Inferior Goods
Sources and Further Reading
Quick Reference
- Measures demand response to income changes
- Used to classify goods
- Essential for demand forecasting
Frequently Asked Questions (FAQs)
What does high income elasticity mean?
Demand increases significantly when income rises.
Can income elasticity be negative?
Yes, this indicates inferior goods.
Is income elasticity constant?
No, it can change over time and across income levels.
