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Income elasticity of demand

 
Investment Dictionary: Income Elasticity Of Demand
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A measure of the relationship between a change in income and a change in quantity of a good demanded:

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The degree to which a demand for a good changes with respect to a change in income depends on whether the good is a necessity or a luxury. The demand for necessities will increase with income, but at a slower rate. This is because consumers, instead of buying more of only the necessity, will want to use their increased income to buy more of a luxury. During a period of increasing income, demand for luxury products tends to increase at a higher rate than the demand for necessities.

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Wikipedia: Income elasticity of demand (YED)
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In economics, the income elasticity of demand measures the responsiveness of the demand of a good to the change in the income of the people demanding the good. It is calculated as the ratio of the percent change in demand to the percent change in income. For example, if, in response to a 10% increase in income, the demand of a good increased by 20%, the income elasticity of demand would be 20%/10% = 2.

Interpretation

Inferior good's demand falls as consumer income increases.

A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the demand and may lead to changes to more luxurious substitutes.

A positive income elasticity of demand is associated with normal goods; an increase in income will lead to a rise in demand. If income elasticity of demand of a commodity is less than 1, it is a necessity good. If the elasticity of demand is greater than 1, it is a luxury good or a superior good.

A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the demand of a good. These would be sticky goods.

Mathematical definition

More formally, the income elasticity of demand, \ \epsilon_d, for a given Marshallian demand function Q(I,\vec{P}) for a good is

\epsilon_d = \frac{\partial Q}{\partial I}\frac{I}{Q}

or alternatively:

\epsilon_d={Y_1 + Y_2 \over Q_1 + Q_2}\times{\Delta Q \over \Delta Y}

This can be rewritten in the form:

\epsilon_d = \frac{d \ln Q}{d \ln I}

With income I, and vector of prices \vec{P}. Many necessities have an income elasticity of demand between zero and one: expenditure on these goods may increase with income, but not as fast as income does, so the proportion of expenditure on these goods falls as income rises. This observation for food is known as Engel's law.

See also


This entry is from Wikipedia, the leading user-contributed encyclopedia. It may not have been reviewed by professional editors (see full disclaimer)

 
 

 

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