Income Elasticity Of Demand

Loading the player...

What is the 'Income Elasticity Of Demand'

The income elasticity of demand is 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.

BREAKING DOWN '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.

RELATED TERMS
  1. Normal Good

    An economic term used to describe the quantity demanded for a ...
  2. Pricing Power

    An economic term referring to the effect that a change in a firm's ...
  3. Demand Curve

    The demand curve is a graphical representation of the relationship ...
  4. Arc Elasticity

    The elasticity of one variable with respect to another between ...
  5. Demand Schedule

    In economics, the demand schedule is a table of the quantity ...
  6. Elasticity

    A measure of a variable's sensitivity to a change in another ...
Related Articles
  1. Economics

    Economics Basics: Elasticity

    Investopedia Explains: What elasticity is, how to calculate elasticity, the difference between elastic and inelastic curves, and the various factors that impact elasticity.
  2. Economics

    Explaining Quantity Demanded

    Quantity demanded describes the total amount of goods or services that consumers demand at any given point in time.
  3. Fundamental Analysis

    How Demand Changes With a Variation in Price

    What is demand elasticity?
  4. Economics

    What's Demand Elasticity?

    Demand elasticity is the measure of how demand changes as other factors change. Demand elasticity is often referred to as price elasticity of demand because price is most often the factor used ...
  5. Personal Finance

    Why We Splurge When Times Are Good

    The concept of elasticity of demand is part of every purchase you make. Find out how it works.
  6. Economics

    Economics Basics: Conclusion

    Recap of the key learnings from Investopedia's economics tutorial .
  7. Economics

    Economics Basics: Supply and Demand

    Investopedia explains: The Law of Demand, The Law of Supply, Supply and Demand Relationship, Equilibrium, Disequilibrium, and Shifts vs. Movement
  8. Economics

    What is a Normal Good?

    A normal good is any good or service that sees an increase in demand due to an increase in income.
  9. Personal Finance

    Microeconomics: Factors Of Consumer Decision-Making

    by Marc DavisSupply and DemandAlthough economists all agree that the price of a product or service is a major factor in the consumer decision-making process, it's not the only factor, and it ...
  10. Economics

    What Is Supply?

    Supply is the amount of goods a producer is willing to produce at a given price, and is one of the most basic concepts in economics.
RELATED FAQS
  1. What are some examples of demand elasticity other than price elasticity of demand?

    Learn about income elasticity of demand and cross elasticity of demand and how to interpret these two measures of demand ... Read Answer >>
  2. Under what circumstances might price elasticity significantly change?

    Discover under what circumstances price elasticity of demand might change and why it is such an important economic concept ... Read Answer >>
  3. What types of consumer goods demonstrate the price elasticity of demand?

    Learn how the price elasticity of demand is more sensitive for some types of consumer goods than others, and see what factors ... Read Answer >>
  4. How does price elasticity change in relation to supply and demand?

    Learn about how variations in price elasticity affect the supply and demand curves and what factors cause differences in ... Read Answer >>
  5. If a particular good's price elasticity is high, does this mean the supplier should ...

    Learn the basics of price elasticity of supply and demand and how each influences a company's production of goods and pricing ... Read Answer >>
  6. How do you quantify price elasticity?

    Learn how to calculate the coefficient for price elasticity, enabling you to approximate how sensitive supply and demand ... Read Answer >>
Hot Definitions
  1. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  2. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  3. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  4. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  5. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  6. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
Trading Center