1.1.4 - Income elasticity of demand
Learn to calculate how demand responds to income and use the sign and size of the result to distinguish normal, luxury and inferior goods.
Income response and calculation
Changing income can alter purchases even when the product’s own price stays the same.
Income elasticity of demand (YED) measures the responsiveness of quantity demanded to a change in consumers’ income, with price and other influences held constant. It measures an income-driven shift of demand, unlike PED’s movement along a fixed demand curve caused by the good’s own price.
Income elasticity of demand
Illustrative data: monthly income rises from £2,000 to £2,200, and the quantity of restaurant meals bought at unchanged prices rises from 10 to 12. Income rises , while meals rise . YED = 20 ÷ 10 = 2. Quantity rises by twice the percentage income change over this interval. Elasticity has no unit.
Keep signs. If income rises 10% and quantity falls 5%, YED = −5 ÷ 10 = −0.5. This negative sign has an economic meaning; it must not be removed when classifying the good. If income falls and purchases of a normal good fall too, dividing two negative percentages produces positive YED. Use original bases unless the question specifies another method; supplied percentage changes can be divided directly.
Normal and luxury goods
For a normal good, consumers buy more as income rises, holding price and other influences constant.
Normal goods have positive YED. A value between 0 and 1 means demand rises less than proportionately with income. For example, YED +0.4 means a 10% income rise is associated with roughly 4% more quantity demanded for a small change. These goods are often necessities: households may buy better food or more basic services as they become richer, but do not need twice as many basic items when income doubles.
A luxury good has YED greater than 1: demand rises more than proportionately with income. Optional holidays or premium leisure services can fit this pattern for some consumers. Luxury goods are a subset of normal goods, so YED +2 means both normal and luxury; it is not a choice between mutually exclusive categories. At YED +1, quantity and income change proportionately. At YED 0, demand does not respond to income over the measured range.
“Luxury” here classifies the income response, not just a high price or an attractive appearance. A costly item that is indispensable to a particular consumer may have low positive YED. Estimates can change with income levels: a product initially treated as a luxury may become an everyday necessity for a wealthier household. Distinguish YED from PED: a positive income response does not tell you the size of a response to the product’s own price.
Inferior goods and demand shifts
An inferior good is bought less as income rises because consumers switch towards alternatives they prefer.
Inferior goods have negative YED. The label does not mean defective, unsafe or morally undesirable. An illustrative household may use fewer budget coach journeys as rising income makes rail travel affordable. For that household and income range, coach travel can be inferior. For another consumer who values convenient coach routes, it may be normal. Classification requires evidence about the income response.
If income rises and YED is negative, the demand curve shifts left: less is demanded at every given price. If income falls, demand for that inferior good may rise, shifting right. For a normal good, the directions reverse. These are shifts, so do not describe the resulting increase in demand as a movement caused by a lower ticket price when price was held constant.
An illustrative discount-food retailer estimates YED −0.3. A 5% income fall implies an approximate quantity rise of , if the estimate remains valid and other conditions stay unchanged. This prediction is conditional, not a guarantee: tastes, population, quality and rivals’ prices may also change. The coefficient records behaviour in a particular setting rather than an unchanging property printed on the product.