Income Elasticity Of Demand

Updated Jan 8, 2023

Definition of Income Elasticity of Demand

Income elasticity of demand is a measure of how the quantity demanded of a good or service changes in response to a change in consumers’ income. It is calculated as the percentage change in quantity demanded of a good or service divided by the percentage change in income.

Example

To illustrate this, let’s look at the demand for luxury cars. For the sake of this example, we’ll assume that the quantity demanded of luxury cars increases by 10% if consumers’ income increases by 5%. This means that the income elasticity of demand for luxury cars is 2 (i.e., 10%/5%). Or in other words, for every 1% increase in income, the demand for luxury cars increases by 2%.

Why Income Elasticity of Demand Matters

Income elasticity of demand is an important concept for businesses and economists alike. For businesses, it helps them to understand how changes in income affect the quantity demanded of their products and services. This, in turn, helps them to make better decisions about pricing, marketing, and production.

Meanwhile, for economists, it helps them to understand how changes in income affect the overall economy. This, in turn, helps them to make better decisions about fiscal and monetary policy.