Income Elasticity of Demand: Videos & Practice Problems

The formula for calculating income elasticity of demand (YED) is:

$\frac{\%∆Q}{\%∆I}$

Here, $∆Q$ represents the percentage change in quantity demanded, and $∆I$ represents the percentage change in income. This formula helps determine how sensitive the demand for a good is to changes in consumer income.

Interpreting the income elasticity of demand (YED) involves understanding the sign and magnitude of the calculated value:

• Positive YED > 1: Indicates a luxury normal good. Demand increases more than proportionally as income rises.
• Positive YED < 1: Indicates a necessity normal good. Demand increases less than proportionally as income rises.
• Negative YED: Indicates an inferior good. Demand decreases as income rises.

This interpretation helps categorize goods based on how consumer demand responds to income changes.

Normal goods and inferior goods differ in their income elasticity of demand (YED):

• Normal Goods: These have a positive YED. If YED > 1, they are luxury goods, meaning demand increases more than proportionally with income. If YED < 1, they are necessities, meaning demand increases less than proportionally with income.
• Inferior Goods: These have a negative YED. Demand for these goods decreases as income increases, indicating that consumers buy less of these goods as they become wealthier.

This distinction helps in understanding consumer behavior and market dynamics.

To calculate the percentage change in quantity demanded and income for income elasticity of demand (YED), use the midpoint method:

Percentage Change in Quantity Demanded:

$\frac{∆Q}{(Q}$₂+Q₁)/2

Percentage Change in Income:

$\frac{∆I}{(I}$₂+I₁)/2

Here, $∆Q$ and $∆I$ represent the changes in quantity demanded and income, respectively. $Q$₁ and $Q$₂ are the initial and final quantities demanded, while $I$₁ and $I$₂ are the initial and final incomes.

Goods with high income elasticity of demand (YED > 1) are typically luxury items. Examples include:

• Luxury Cars: As income increases, consumers are more likely to purchase high-end vehicles.
• Designer Clothing: Higher income leads to increased spending on premium fashion brands.
• Travel and Tourism: With more disposable income, people tend to spend more on vacations and travel experiences.
• High-End Electronics: Items like the latest smartphones, high-definition TVs, and advanced gadgets see increased demand with rising incomes.

These goods are considered luxuries because their demand grows more than proportionally with income increases.