What does income elasticity of demand measure, and what is the formula?

Income elasticity of demand measures how responsive the quantity demanded of a good is to a change in consumers' real income, with the good's own price held constant. The formula is the percentage change in quantity demanded divided by the percentage change in income, each percentage change being the change divided by the original value, multiplied by 100. Unlike price elasticity of demand, the sign carries real information: a positive value identifies a normal good and a negative value identifies an inferior good.

Average household income in a region rises from £20,000 to £22,000 and annual demand for restaurant meals rises from 500 to 560 per hundred households. Calculate the income elasticity of demand and classify the good.

Percentage change in income: +£2,000 divided by 20,000, multiplied by 100, gives +10%. Percentage change in quantity: +60 divided by 500, multiplied by 100, gives +12%. Income elasticity of demand is +12 divided by +10, which is +1.20. The sign is positive, so restaurant meals are a normal good. The value is greater than +1, so demand is income elastic and the good behaves as a luxury: demand grows proportionately faster than income, and it would also fall proportionately faster in a downturn.

Household income rises by 10% and weekly sales of a supermarket's cheapest own-label bread fall from 800 to 760 loaves. Calculate the income elasticity of demand and say what type of good this is.

Percentage change in quantity: -40 divided by 800, multiplied by 100, gives -5%. Percentage change in income is +10%. Income elasticity of demand is -5 divided by +10, which is -0.50. The value is negative, so budget bread is an inferior good: as households became better off they bought less of it, trading up to bakery or branded loaves instead. The modulus of 0.50 shows the switch away was proportionately smaller than the income rise, so the effect is real but moderate.

Household income rises from £30,000 to £31,500 and annual demand for salt rises from 200 to 204 packs per hundred households. Calculate the income elasticity of demand and interpret it.

Percentage change in income: +£1,500 divided by 30,000, multiplied by 100, gives +5%. Percentage change in quantity: +4 divided by 200, multiplied by 100, gives +2%. Income elasticity of demand is +2 divided by +5, which is +0.40. The positive sign makes salt a normal good, but the value lies between 0 and +1, so demand is income inelastic: it is a necessity. Households buy roughly the same amount whatever happens to their income, because there is a limit to how much salt anyone needs.

Average income in a town falls from £25,000 to £24,000 and monthly sales of tinned value-range soup rise from 1,500 to 1,590. Calculate the income elasticity of demand and explain the sign.

Percentage change in income: -£1,000 divided by 25,000, multiplied by 100, gives -4%. Percentage change in quantity: +90 divided by 1,500, multiplied by 100, gives +6%. Income elasticity of demand is +6 divided by -4, which is -1.50. The value is negative because demand rose while income fell - the two moved in opposite directions - and that is exactly what defines an inferior good. The large modulus shows the switching towards the value range was strong, which is typical of budget lines during a squeeze on household budgets.

Household income rises from £40,000 to £44,000 and annual demand for overseas holidays rises from 1,200 to 1,440 per thousand households. Calculate the income elasticity of demand.

Percentage change in income: +£4,000 divided by 40,000, multiplied by 100, gives +10%. Percentage change in quantity: +240 divided by 1,200, multiplied by 100, gives +20%. Income elasticity of demand is +20 divided by +10, which is +2.00. Overseas holidays are a normal good and strongly income elastic - a luxury in the economic sense. Demand for them grows twice as fast as income in a boom, and it would be expected to contract twice as fast in a recession, which makes the market highly cyclical.

CCEA A-Level Economics 4410

Key Economic Concepts

Topic overview The four factors of production Positive statements and normative judgements Economic agents and what they are trying to achieve Capital goods and consumption goods Product markets and factor markets

The Basic Economic Problem of Scarcity and Choice

Topic overview Scarcity, choice and opportunity cost Drawing and reading the production possibility frontier Using a PPF to show choice, opportunity cost, efficiency and growth Why an economy operates inside its frontier Specialisation and the division of labour Free market, planned and mixed economies

Demand and Supply in Product Markets

Topic overview What determines demand and what determines supply Movements along a curve versus shifts of a curve Why the demand curve slopes downwards Why the supply curve slopes upwards: marginal cost and the profit incentive Consumer surplus and producer surplus When consumers do not behave rationally

Markets and Equilibrium

Topic overview Market equilibrium and how markets clear How shifts in demand and supply change the equilibrium Price signals, incentives, rationing and the role of profit Joint, composite and derived demand and joint supply Tracing effects between interrelated markets Community surplus and allocative efficiency Demand and supply in housing, energy and commodity markets Indirect taxes and subsidies: impact and incidence

Elasticity of Demand and Supply

Topic overview Price elasticity of demand: measuring and interpreting Income and cross elasticity: normal, inferior, substitutes and complements Price elasticity of supply What determines the value of an elasticity Elasticity and total revenue How useful is elasticity for firms and government?

Factor Markets: Labour

Topic overview How a competitive labour market sets the wage Elasticity of labour demand and labour supply Wage differentials and why they persist Economic rent and transfer earnings Flexibility: trade unions, welfare and migration Minimum wages and government intervention in the labour market

Market Failures and Imperfections

Topic overview Market equilibrium, the social optimum and the meaning of market failure Externalities: private, external and social costs and benefits Community surplus and the externality diagrams Calculating and interpreting welfare loss Public goods, quasi-public goods and the free rider problem The consequences of missing markets for public goods Merit goods and demerit goods Information gaps and asymmetric information The consequences of merit goods, demerit goods and information failure Market power and other market imperfections Income and wealth inequality Absolute and relative poverty

Government Intervention in Markets

Topic overview Why governments step into markets Indirect taxes Subsidies, and choosing between taxes and subsidies Maximum and minimum prices State provision Regulation Information provision Tradeable pollution permits Government failure

The Circular Flow of Income

Topic overview Households, firms and the two-way flow Injections and withdrawals in an open economy with government Equilibrium and change in the circular flow

Measuring National Income

Topic overview Three routes to the same total: income, expenditure and output GDP as a measure of welfare and its limitations Domestic or national? GDP and GNP compared Nominal and real values: correcting for price changes Total and per capita measures

Aggregate Demand

Topic overview The four components of aggregate demand Why the aggregate demand curve slopes downwards Movements along and shifts in aggregate demand Factors that shift aggregate demand Investment: gross, net and fixed capital

Aggregate Supply

Topic overview Why short-run aggregate supply slopes upwards Factors that shift short-run aggregate supply Movements along and shifts in aggregate supply From the short run to the long run What determines long-run aggregate supply Keynesian and neoclassical views of long-run aggregate supply

Macroeconomic Equilibrium

Topic overview How aggregate demand and aggregate supply determine equilibrium Applying AD-AS analysis to growth and unemployment Applying AD-AS analysis to inflation

Macroeconomic Objectives

Topic overview Why governments target inflation, unemployment, the external balance and growth Objectives beyond the main four: the environment and the distribution of income and wealth Picturing inequality: the Lorenz curve and the Gini coefficient Where the objectives collide: the main policy conflicts Judging the trade-offs: how sharp is a conflict?

Inflation

Topic overview Inflation, deflation and disinflation: what the words actually mean Measuring the rate: the CPI and the RPI Working with index numbers Building a price index: the basket and the significance of weights Demand-pull and cost-push inflation The costs and consequences of inflation and deflation The policy response to inflation

Unemployment

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Economic Growth

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Fiscal Policy and Its Effects

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Monetary Policy

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Exchange Rates and the National Economy

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Perfect Competition

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Monopoly

Topic overview Barriers to entry Monopoly equilibrium and its consequences Price discrimination Natural monopoly Creative destruction

Monopolistic Competition

Topic overview The firm's demand curve when products are differentiated Short-run equilibrium for the firm Long-run equilibrium and excess capacity How the market moves from the short run to the long run

Oligopoly

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Contestable Markets

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Economic Development

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Balance of Payments

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Exchange Rate Systems and Competitiveness

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European Union (EU)

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Monetary Policy and the Financial Sector

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Fiscal Deficits and the National Debt

Topic overview The deficit and the debt: a flow and a stock What determines the size of a fiscal deficit Discretionary policy and automatic stabilisers Financing the deficit: bonds, borrowing and crowding out The benefits and costs of a deficit and of the national debt Fiscal policy, macroeconomic objectives and economic agents

Macroeconomic Policies and Objectives in a Global Economy

Topic overview Comparing the performance of different economies Global events and how they reach the domestic economy Responding to external demand and supply shocks Problems and constraints facing policymakers How the priority given to macroeconomic objectives has changed Comparing policies against one another

Quantitative Skills in Economics

Topic overview Ratios, shares and proportions in economic data Percentages and percentage changes in economic data Averages, medians and quantiles Index numbers, weighting and rebasing Converting money values to real values Cost, revenue and profit Elasticity: calculating the number and reading its meaning Choosing and reading economic charts and diagrams Interpreting economic data critically

Elasticity of Demand and Supply

Income and cross elasticity: normal, inferior, substitutes and complements

1 thing to know
Unit AS 1

Overview

Income elasticity of demand measure, full interpretation of income elasticity of demand values and normal good and an inferior good.

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Answer each one before you reveal it.

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Key term

Set out the full interpretation of income elasticity of demand values, from strongly negative to strongly positive.

Questions from this subtopic

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1
What does income elasticity of demand measure, and what is the formula?
Model answer
Income elasticity of demand measures how responsive the quantity demanded of a good is to a change in consumers' real income, with the good's own price held constant. The formula is the percentage change in quantity demanded divided by the percentage change in income, each percentage change being the change divided by the original value, multiplied by 100. Unlike price elasticity of demand, the sign carries real information: a positive value identifies a normal good and a negative value identifies an inferior good.
2
Average household income in a region rises from £20,000 to £22,000 and annual demand for restaurant meals rises from 500 to 560 per hundred households. Calculate the income elasticity of demand and classify the good.
Model answer
Percentage change in income: +£2,000 divided by 20,000, multiplied by 100, gives +10%. Percentage change in quantity: +60 divided by 500, multiplied by 100, gives +12%. Income elasticity of demand is +12 divided by +10, which is +1.20. The sign is positive, so restaurant meals are a normal good. The value is greater than +1, so demand is income elastic and the good behaves as a luxury: demand grows proportionately faster than income, and it would also fall proportionately faster in a downturn.
3
Household income rises by 10% and weekly sales of a supermarket's cheapest own-label bread fall from 800 to 760 loaves. Calculate the income elasticity of demand and say what type of good this is.
Model answer
Percentage change in quantity: -40 divided by 800, multiplied by 100, gives -5%. Percentage change in income is +10%. Income elasticity of demand is -5 divided by +10, which is -0.50. The value is negative, so budget bread is an inferior good: as households became better off they bought less of it, trading up to bakery or branded loaves instead. The modulus of 0.50 shows the switch away was proportionately smaller than the income rise, so the effect is real but moderate.
4
Household income rises from £30,000 to £31,500 and annual demand for salt rises from 200 to 204 packs per hundred households. Calculate the income elasticity of demand and interpret it.
Model answer
Percentage change in income: +£1,500 divided by 30,000, multiplied by 100, gives +5%. Percentage change in quantity: +4 divided by 200, multiplied by 100, gives +2%. Income elasticity of demand is +2 divided by +5, which is +0.40. The positive sign makes salt a normal good, but the value lies between 0 and +1, so demand is income inelastic: it is a necessity. Households buy roughly the same amount whatever happens to their income, because there is a limit to how much salt anyone needs.
5
Average income in a town falls from £25,000 to £24,000 and monthly sales of tinned value-range soup rise from 1,500 to 1,590. Calculate the income elasticity of demand and explain the sign.
Model answer
Percentage change in income: -£1,000 divided by 25,000, multiplied by 100, gives -4%. Percentage change in quantity: +90 divided by 1,500, multiplied by 100, gives +6%. Income elasticity of demand is +6 divided by -4, which is -1.50. The value is negative because demand rose while income fell - the two moved in opposite directions - and that is exactly what defines an inferior good. The large modulus shows the switching towards the value range was strong, which is typical of budget lines during a squeeze on household budgets.
6
Household income rises from £40,000 to £44,000 and annual demand for overseas holidays rises from 1,200 to 1,440 per thousand households. Calculate the income elasticity of demand.
Model answer
Percentage change in income: +£4,000 divided by 40,000, multiplied by 100, gives +10%. Percentage change in quantity: +240 divided by 1,200, multiplied by 100, gives +20%. Income elasticity of demand is +20 divided by +10, which is +2.00. Overseas holidays are a normal good and strongly income elastic - a luxury in the economic sense. Demand for them grows twice as fast as income in a boom, and it would be expected to contract twice as fast in a recession, which makes the market highly cyclical.

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Key Economic Concepts

The Basic Economic Problem of Scarcity and Choice

Demand and Supply in Product Markets

Markets and Equilibrium

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AThe initial spending becomes income for those who receive it.

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CThe total effect on demand exceeds the original injection.

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