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Definition – What is income elasticity of demand?
Income elasticity of demand is a measurement of how much demand for a good or service will increase if income increases.
A higher income elasticity of demand means that if incomes increase, demand for the good or service will greatly increase. If incomes fall, demand will significantly decrease. An example would be cars. When incomes go up, more people buy larger and fancier cars. When incomes go down, cars are less frequently bought.
A lower income elasticity of demand means that if incomes increase, demand for the good or service will slightly increase. If incomes fall, demand will slightly decrease.
A zero income elasticity of demand means that if incomes rise or fall, demand for the good or service will not change.
A negative income elasticity of demand means that if incomes increase, demand for the good or service will fall. If incomes fall, demand will increase. An example would be public transportation – when incomes go up, more people can afford their own transportation, and when incomes go down, more people take public transportation.
Formula – How to calculate Income Elasticity of Demand
Income Elasticity of Demand = % Change in Demand / % Change in Income
% Change in Demand = (Demand End – Demand Start) / Demand Start
% Change in Income = (Income End – Income Start) / Income Start
Example
Demand at the start of the period is 1,000 units and 2,000 units at the end of the period. In the same period, income increased from 4,000 to 5,000.
% Change in Demand = (2,000 – 1,000) / 1,000 = 1,000 / 1,000 = 1
% Change in Income = (5,000 – 4,000) / 4,000 = 1,000 / 4,000 = 0.25
Income Elasticity of Demand = 1 / 0.25 = 4
Therefore, income elasticity of demand is 4.
Sources and more resources
- Wikipedia – Income Elasticity of Demand – Overview of the income elasticity of demand forumla.
- Franny Chan – Macroeconomics – Income Elasticity of Demand – An explanation of the formula to calculate income elasticity of demand.
- Georgia State University – Econport – Income Elasticity – Explains the concept of income elasticity.
- OECD Glossary – Income Elasticity of Demand – The OECD’s glossary entry for Income Elasticity.
- Franny Chan Macroeconomics – Income Elasticity of Demand – A condensed explanation of Income Elasticity.
- Thayer Watkins – Income Elasticity of Demand (or What Happens to the Quantity Demanded of Goods When Income Changes?) – Formula summary of Income Elasticity of Demand.