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Business

Study Notes

Income elasticity of demand

Level:
AS, A Level
Board:
AQA, Edexcel, OCR, IB

The amount that customers demand is affected by price (Ped). However, it is also affect by the incomes of consumers. This leads onto another important elasticity – the income elasticity of demand (often shortened to Yed).

Income elasticity of demand measures the relationship between a change in quantity demanded for good X and a change in real income. The formula for calculating income elasticity is:

% change in demand divided by the % change in income

Most products have a positive income elasticity of demand. So as consumers' income rises more is demanded at each price.

1.Normal necessities have an income elasticity of demand of between 0 and +1 for example, if income increases by 10% and the demand for fresh fruit increases by 4% then the income elasticity is +0.4. Demand is rising less than proportionately to income.

2.Luxury goods and services have an income elasticity of demand > +1 i.e. demand rises more than proportionate to a change in income – for example a 8% increase in income might lead to a 10% rise in the demand for restaurant meals. The income elasticity of demand in this example is +1.25.

However, there are some products (economists call them "inferior goods") which have a negative income elasticity of demand, meaning that demand falls as income rises. Typically inferior goods or services tend to exist where superior goods are available if the consumer has the money to be able to buy it. Examples include the demand for cigarettes, low-priced own label foods in supermarkets and the demand for council-owned properties.

The income elasticity of demand is usually strongly positive for

  • Fine wines and spirits, high quality chocolates (e.g. Lindt) and luxury holidays overseas
  • Consumer durables - audio visual equipment, 3G mobile phones and designer kitchens
  • Sports and leisure facilities (including gym membership and sports clubs)

In contrast, income elasticity of demand is lower for

  • Staple food products such as bread, vegetables and frozen foods
  • Mass transport (bus and rail)
  • Beer and takeaway pizza!
  • Income elasticity of demand is negative (inferior) for cigarettes and urban bus services

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