Microeconomics for Business/Solution to Mathematical Questions of Income Elasticity of Demand

Solution to Mathematical Questions of Income Elasticity of Demand

Consumers' income is one of the most significant determinants of demand for any product and services apart from its own price and price of related goods. In general, there is a positive relationship between the income of the consumer and the quantity demanded of the product or services. 

In simple words, the demand for normal goods and services increases when there is an increase in income and vice versa. Thus, the responsiveness of demand of the commodity to the change in income of the consumer is termed as income elasticity of demand.

Income elasticity of demand E_Y for a product, Say, X, with respect to change in money income Y can be defined as;

E_Y=Percentage change in demand/Percentage change in income

There is a positive relationship between the income of the consumer and quantity demanded of the commodity. But the exception is in case of inferior goods the income elasticity of demand is negative just like price elasticity of demand in case of Giffen goods. The demand for inferior goods decreases with an increase in income and vice versa. 

It means when there is an increase in income people prefer to purchase high quality and luxurious goods. For example, with an increase in income people will buy more rice and less quantity of inferior goods like ragi, wheat, etc. and people use more taxis and less bus service and so on. For all the normal goods thus income elasticity is positive through the degree of elasticity varies depending on the nature of commodities. 

The consumer goods can be categorized into essential or necessities, comforts, and luxurious goods. The income elasticity of demand for these categories of goods is also different.

Nature of Commodities, Income Elasticity, and Expenditure

Commodities	Coefficient of income elasticity	Change in demand
Necessary	Less than unit	Less than proportionate change in income
Comfort	Almost equal to a unit	Almost equal to proportionate change in income
Luxurious	Greater than unit	More than proportionate increase in income

The concept of income the elasticity of demand has two significant uses; first for the demand forecasting. If income is expected to increase in the near future the demand is also expected to be increased and vice versa. Second, to differentiate the nature and type of the product. Whether the goods are normal, inferior, or luxurious can be known by the measurement of income elasticity of demand. 

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