Income Elasticity of Demand – SS2 Economics Lesson Note (First Term)

Income elasticity of demand is the degree of responsiveness of the quantity demanded of a commodity to a small change in consumers’ income. It measures how a change in the income of consumers affects the quantity of the commodity they demand.

Behavioural objectives

By the end of the lesson, students should be able to:

• define income elasticity of demand;
• write and use the formula for income elasticity of demand;
• explain when income elasticity is equal to unity, less than unity and greater than unity;
• distinguish positive from negative income elasticity of demand and state the goods each applies to;
• calculate income elasticity between two points and name the type of good.

How is income elasticity of demand calculated?

Income elasticity of demand is expressed mathematically as:

Income elasticity of demand = % change in quantity demanded ÷ % change in income

What do the values mean?

• When the percentage change in quantity demanded is equal to the percentage change in income, income elasticity is equal to unity (one).
• When the percentage change in income is greater than the percentage change in quantity demanded, income elasticity is less than unity. Demand is therefore income inelastic.
• When the percentage change in quantity demanded is greater than the percentage change in income, income elasticity is greater than unity. Demand is therefore income elastic.

What are the types of income elasticity of demand?

1. Positive income elasticity of demand: an increase in the income of the consumer also leads to an increase in the quantity of the commodity demanded. This applies mainly to normal goods.
2. Negative income elasticity of demand: an increase in the income of consumers leads to a decrease in the quantity of the commodity demanded. This applies to inferior goods.

Positive income elasticity of demand is for normal, superior or luxury goods, whereas negative income elasticity of demand is for abnormal or inferior goods.

Worked example: calculating income elasticity of demand

The table below shows the income of a consumer and the quantity demanded of different commodities.

1. Calculate the income elasticity between (i) A and B, (ii) C and D, (iii) E and F.
2. What kind of good relationship is there between (i) A and B, (ii) C and D?

Solution

Income elasticity of demand = % change in quantity demanded ÷ % change in income

(a) (i) Between A and B

• % change in quantity demanded = (96 – 120) ÷ 120 × 100 = -20%
• % change in income = (36,000 – 20,000) ÷ 20,000 × 100 = 80%
• Income elasticity = -20 ÷ 80 = -0.25

(a) (ii) Between C and D

• % change in quantity demanded = (200 – 160) ÷ 160 × 100 = 25%
• % change in income = (44,000 – 40,000) ÷ 40,000 × 100 = 10%
• Income elasticity = 25 ÷ 10 = 2.5

(a) (iii) Between E and F

• % change in quantity demanded = (252 – 240) ÷ 240 × 100 = 5%
• % change in income = (47,000 – 45,000) ÷ 45,000 × 100 = 4.44%
• Income elasticity = 5 ÷ 4.44 = 1.125

(b) Type of good

• (i) A and B: Giffen good or inferior good. Income rises while quantity demanded falls, so elasticity is negative.
• (ii) C and D: normal good. Income and quantity demanded rise together, so elasticity is positive.

Evaluation

1. Define income elasticity of demand.
2. Write the formula for income elasticity of demand.
3. What does it mean when income elasticity of demand is greater than unity?
4. Distinguish between positive and negative income elasticity of demand, and state the type of good each applies to.

Assignment

Using the table in the worked example, calculate the income elasticity of demand between D and E. State whether demand is income elastic or income inelastic, and say what type of good it is.