Income Elasticity

This post is for educational purposes and should not be considered as investment advice. All trading involves risk. Only risk capital you're prepared to lose. Past performance does not guarantee future results.
Income

If the consumer income increases, the consumer will be able to purchase a higher quantity of goods and services. The income elasticity of the demand, measures the responsiveness of the demand with respect to changes in the consumer income.

The income elasticity of the demand is defined as the proportional change in the quantity demanded, divided the proportional change in the income.

ei = (ΔQ/Q)/(ΔI/I)

Where:

  • ei income elasticity
  • ΔQ change in quantity
  • ΔI change in income

Graphically:

Demand shifts to right when income increases

When the income increases, the demand shifts to the right.

If we see the quantity demanded as a function of the income:

Demand as a function of the Income

Tipes of Goods acording to the Income Elasticity

The demand of some good will be more sensitive to variations in the income. For example: the demand for foods doesn’t variate a lot when the income increases or decreases. The demand for travel or luxury items has a bigger income elasticity.

According to the income elasticity, goods can be classified in:

  • Normal Goods: Income elasticity is positive. The mayority of goods are normal.
    • Luxury Goods: A normal good will be a luxury good if the income elasticity is bigger than 1.
  • Inferior Goods: Income elasticity is negative. Some goods are inferior goods because when the income increases, the consumer prefers to purchase a substitute. For example, if a person uses the bus to go to work, and her income increases a lot, she will buy a car and stop using the bus.

Inferior Good

Inferior Good

The same good can have different income elasticities depending on the income level, as we can see in the following chart:

Income Elasticity

When the income is low, the good is a luxury good. After some level of income, the good is still a normal good, but it is not a luxury good. After a higher income level, the good is an inferior good. As the income keeps increasing, the demand for the good diminishes until it disappears.

It is noteworthy that this pattern can be seen in a lot of modern goods. Also, if we take into account that economic growth is an almost constant phenomena in the long term, this pattern can be translated into a “product life-cycle” pattern.

 

Tags: 

You May Also Like

This content is for information and educational purposes only and should not be considered investment advice nor portfolio management. Past performance is not an indication of future results. Leveraged products can carry a high degree of risk.
Contact | About | Terms of use | © economicpoint.com