2.21 : Income Elasticity of Demand

Income elasticity of demand quantifies how the quantity demanded of a good responds to changes in consumer income. It is calculated as the ratio of the percentage change in quantity demanded to the percentage change in income.

Classification of Goods:

• Inferior Goods: These goods exhibit a negative income elasticity. As individuals' income increases, their consumption of these goods decreases. For instance, as a person's financial situation improves, they might prefer dining at restaurants over purchasing instant noodles.
• Normal Goods: These goods exhibit a positive income elasticity. The demand for normal goods increases as consumer income rises. A typical example involves upgrading from public transportation to owning a personal vehicle for daily commuting.
• Luxury Goods: These goods have an income elasticity greater than one, indicating that demand increases more than proportionately as income rises. Imagine someone choosing to buy designer clothing instead of generic brands as their disposable income increases.

Understanding income elasticity helps businesses forecast demand under varying economic scenarios and aids governments in assessing how fiscal policies, like tax adjustments, might affect consumer expenditure.