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Home » Economics Homework Help » Microeconomics Help » Income Elasticity
Income Elasticity
Another important concept of elasticity of demand is income elasticity of demand; income elasticity of demand shows the degree of responsiveness of quantity demanded of a good to a small change in the income of consumers. The degree of response of quantity demanded to a change in income is measured b dividing the proportionate change in quantity demanded by the proportionate change in income. Thus more precisely the income elasticity of demand may be defined as the ratio of the percentage change in purchase of a good to a percentage change in income which induces the former.

Income elasticity = percentage change in purchases of a good / percentage change income

Income elasticity normal good and inferior goods

Besides zero income elasticity is significant because it represents dividing line between positive income elasticity on the one side and negative income elasticity on the other. On the one suede when income elasticity is mroethan zero (that is positive) then an increase in income leads to the increase in quantity demanded of the good. This happens in cse of normal goods. On the other side of zero income elasticity are all those goods whose income elasticity is less than zero (that is negative) and in shush cases increase in income will lead to the fall in quantity demanded of the goods. Goods having negative income elasticity are known as inferior goods. Goods with positive income elasticity are called normal goods. We thus see that zero income elasticity is a significant value for it helps us to distinguish normal goods from inferior goods.

Income elasticity luxuries and necessities

Another significant value of income elasticity is unit. This is because when income elasticity of demand for a good is equal to one then proportion of come spent on the good remains the same as consumer a income increases. Income elasticity of unity also represents a useful dividing line. If the income elasticity for a goods is greater than one the proportion of consumer income spent on the good rises as consumer income increase that is that good bulks large in consumer expenditure as he becomes riche. On the other hand if income elasticity for a good is less than one, the proportion of consumer income spent on it falls as his income rises, that is th good becomes relatively less important in consumer expenditure as his income rises. A good having income elasticity more thane and which the fore bulks larger in costumer budget as he becomes richer is called a luxury. A good with an income elasticity less than one and which claims declining proportion to of consumer income as he become richer is called a necessity. It should however be noted that the definition of luxuries and necessities on the basis of income elasticity may not can form to their definitions in English dictionary because the dictionary luxuries may be necessities and its necessities may be luxuries according to the above definition. But in economic theory it is useful to call the goods with income elasticity greater than one as luxuries and gods with income elasticity less than one as necessities.

Importance of income elasticity for business firms

The concept of income elasticity is important of decision making both by business firms and industries. First the firs producing products which have high income elasticity have great potential for growth I an expanding economy. For example if or a firm product income elasticity of demand is greater than one, it means that it will gain more than proportionately to the increase in national income. Thus firms which are producing products Haig high income elasticity are more interested in forecasting the level of aggregate economic activity level of nation income because the demand for their products will greatly depend on the level of overall economic activity. Further as seen above the demand for luxuries is highly income elastic. Therefore the demands for luxuries fluctuate vey much during different phases of business cycles. During boom periods demand for luxuries increase very much and decline sharply during recessionary periods.

The concept of income elasticity of demand shows clearly why farmers income do not rise equal to that of urban people engaged in manufacturing industries. Income elasticity of demand for agricutlated products such as fudging is less than one. This implies that it is difficult for ht farmer’s income form agriculture to increase In proportion to the expanding national income. Thus farmers cannot keep up with the urban people who derive their incomes from industries producing good with high income elasticity of demand.

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