The income elasticity of demand seeks to measure the proportion in the variation of the demand for a good, compared to changes in the income levels of consumers.
When, in real terms, the income of consumers increases their purchasing power expands. This results in greater purchases of goods and services.
The income elasticity of demand seeks to measure these changes. The concept of income elasticity of demand is often referred to by various traders as income elasticity.
Depending on how the income levels of consumers vary, the demands of some goods can rise considerably. To consider the proportion of the real increase in income that individuals will spend on the acquisition of goods, is what is intended to provide the income elasticity of demand.
Importance of income elasticity of demand
The importance of this concept is that depending on the value of the income elasticity coefficient, it is possible to arrive at a classification of economic goods. Thus, its importance is powerful, it allows to know in depth the behavior of the consumer.
Formula for calculating the income elasticity of demand
The income elasticity is obtained by dividing the percentage variation of the quantity demanded of a good by the percentage variation of income. Therefore, its expression is as follows:
Income elasticity and types of economic goods
In consequence of the changes experienced in the income levels of individuals or consumers and taking into account the income elasticity coefficient, we get to know the economic goods . Let’s see its classification:
- Normal goods:Are those in which income elasticity has positive values:
- Luxury goods:Those whose income elasticity maintain values greater than one.
- Lower goods:This is said, to economic goods in which income elasticity has negative values.
- Essentialgoods : These goods are those that have positive elasticity, but less than one.
Example of calculation with income elasticity of demand
Through the example that we will give next we will know the process of calculating the income income elasticities. In this sense we will assume that the average income of the consumer increases from 2,900 euros to 2,940. In view of this increase in income, consumers buy 47 kilos of beef, instead of 42 kilograms that they bought prior to the increase in income.
To determine the elasticity coefficient of demand income elasticity we will use the formula outlined above. This is the following:
Step number 1: This step is to determine the top of the formula. That is, the percentage variation in quantities.
- We determine the absolute change in quantities, which is obtained by subtracting the final demand from the initial demand, that is (47 – 42 = 0.05).
- Now dividing this value by the initial demand. Thus we have the following: 0.05 / 42 = 0.0012 which, taken at percentage value, is equal to (0.0012 x 100 = 0.12%).
This 0.12% then represents the percentage variation of the quantities demanded. That is, we have determined the upper part of the formula.
Step number 2: This step consists in determining the bottom of the formula. That is, the percentage variation in income.
- We determine the absolute change in income, which is obtained by subtracting the final income from the initial income, that is (2,940 – 2,900 = -40).
- Now dividing this value by the initial income. Thus we have the following (-40 / 2,900 = 0.014) that taken to percentage value is equal to (0.014 x 100 = 1.4%).
This 1.4% then represents the percentage variation in income. That is, we have determined the bottom of the formula.
Step number 3: In this final step we proceed to replace the values determined in step one and step two in the demand income elasticity formula. Let’s see:
So the income elasticity coefficient is less than one, in positive range. This is a good of necessity, since its elasticity coefficient is less than one on a positive scale. In addition, this result implies that for every 1% that the rent increases, the amount demanded of these goods increases by 0.086%.