Income Elasticity Of Demand

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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.

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.

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