Income Elasticity Of Demand

Definition of 'Income Elasticity Of Demand'


A measure of the relationship between a change in the quantity demanded for a particular good and a change in real income. Income elasticity of demand is an economics term that refers to the sensitivity of the quantity demanded for a certain product in response to a change in consumer incomes. The formula for calculating income elasticity of demand is:

Income Elasticity of Demand = % change in quantity demanded / % change in income

For example, if the quantity demanded for a good increases for 15% in response to a 10%increase in income, the income elasticity of demand would be 15% / 10% = 1.5. The degree to which the quantity demanded for a good changes in response to a change in income depends on whether the good is a necessity or a luxury.

Investopedia explains 'Income Elasticity Of Demand'


Normal goods have a positive income elasticity of demand. As incomes rise, more goods are demanded at each price level. The quantity demanded for normal necessities will increase with income, but at a slower rate than luxury goods. This is because consumers, rather than buying more of the necessities, will likely use their increased income to purchase more luxury goods and services. During a period of increasing incomes, the quantity demanded for luxury products tends to increase at a higher rate than the quantity demanded for necessities. The quantity demanded for luxury goods is very sensitive to changes in income.

Inferior goods have a negative income elasticity of demand - the quantity demanded for inferior goods falls as incomes rise. For example, the quantity demanded for generic food items tends to decrease during periods of increased incomes.

Businesses evaluate income elasticity of demand for various products to help predict the impact of a business cycle of product sales.


Filed Under:

comments powered by Disqus
Hot Definitions
  1. Federal Reserve Note

    The most accurate term used to describe the paper currency (dollar bills) circulated in the United States. These Federal Reserve Notes are printed by the U.S. Treasury at the instruction of the Federal Reserve member banks, who also act as the clearinghouse for local banks that need to increase or reduce their supply of cash on hand.
  2. Benchmark Bond

    A bond that provides a standard against which the performance of other bonds can be measured. Government bonds are almost always used as benchmark bonds. Also referred to as "benchmark issue" or "bellwether issue".
  3. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to sales or total asset figures.
  4. Oil Reserves

    An estimate of the amount of crude oil located in a particular economic region. Oil reserves must have the potential of being extracted under current technological constraints. For example, if oil pools are located at unattainable depths, they would not be considered part of the nation's reserves.
  5. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  6. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
Trading Center