Income elasticity of demand

What is Income Elasticity of Demand?

In simple language, income elasticity of demand refers to the behaviour of a demand for a particular commodity concerning the changes in the consumer’s income.  The sensitivity ratio among the quantity of a given commodity and the subsequent changes in the income of the consumers who are demanding the commodity, all other things being equal, is referred to as income elasticity of demand. Organisations implement income elasticity of demand to predict productivity expansion and loss based on market fundamentals. Firms may strategize how to respond to consumer income using this data, both for their stability and in how they sell their products.

Methodology of Income Elasticity of Demand

The income elasticity of demand works on general methodology. When the economy is in its boom condition, a consumer’s income rises, and the elasticity of demand rises as well because greater income increases the chance that a consumer would buy a firm’s goods and vice-versa.

When The Nature Of The Demand For Goods Is More Elastic

An organisation’s commodity that has more substitutes in the market can easily be substituted with other similar alternative options if they make certain changes in the price of the commodity. Demand reacts very suddenly in the case of elastic goods.

When The Nature Of The Demand For Goods Is More Inelastic

Since consumers perceive inelastic commodities to be indispensable and have no means to locate substitutes if they become too expensive, inelastic commodities have always been in demand. As a result, firms understand that they may price these commodities as they like, in both good and bad economic times.

Types Of Income Elasticity Of Demand

There are five types of income elasticity of demand in total that regulate the entire consumption and production aspects of the market. This five income elasticity of demand is as follows:

• Inelastic Income Elasticity

The demand for the commodity is completely independent of the changes in the income of the consumer. Whatever changes will take place in the income of the consumer, no effect will be there on the consumption of the community.

• Less Than Unitary Income Elasticity

The income elasticity of demand will not exceed the scale of 1, all the changes in demand with respect to income will take place on the scale of less than 1. The quantity demanded of a commodity is less correlated as a consumer’s income rises or falls.

• Unitary Income Elasticity

The income elasticity of demand, in this case, is always equal to 1 no matter what the situation is in the economy. The total change in quantity demanded will be equal to the total change in the consumer’s income. The quantity demanded of a commodity is proportional to the rise or fall in consumer income.

• More Than Unitary Income Elasticity

In this case, the total change in demand for the commodity will always exceed the total change in the overall change in consumer’s income.

• Elastic Income Elasticity Of Demand

In this case, the total change in demand of the commodity will go to an unpredictable extent (considerably to infinity) and always be more than the change in the overall income of the consumer. The calculated amount will exceed 1 in general.

Income Elasticity Of Demand Formula

The process to calculate income elasticity of demand is quite easy, you just have to follow certain steps. These are listed below. Step 1: Determine the annual change in average consumer income. This stage may necessitate further market research to determine a consumer’s typical annual income and changes from the prior year. Step 2: Determine past and present commodity demand. After that, you’ll need to figure out how much was sold and compare it to the prior year. Step 3: Take note of the shift in demand and income. You may now assess the difference in demand and income from the preceding year to the current year. Step 4: Multiply the change in demand by the annual average income.

Income Elasticity Of Demand Interpretations

The results of a business’s on-demand income elasticity computations can be seen in a variety of ways. The perception, on the other hand, differs based on the findings they calculate. Here’s a tutorial to help you comprehend the results of your calculations:

• Decide If The Result Is Favourable Or Bad In Terms Of Your Business

If the income elasticity of demand computation yields a negative result, consumers are more inclined to purchase your demands when their income grows. If they have more income, you need to figure out why they aren’t demanding more of your goods and how to adjust your product or price in advance.

• Match The Calculation To The Sort Of Product You’re Selling (Substitutes)

Examine the many sorts of commodities and how calculations might help you select which ones to sell.

1. Inferior products: In the case of inferior products, the income elasticity of demand is negative, resulting in a reduction in demand as income rises.
2. Normal products: Since this rise in income meets the demand for the commodity, a normal good is the outcome of a positive computation. If they lie within 0 and 1 in the income elasticity of demand calculation, they are considered to be a necessity commodity because consumers buy these products regardless of their income changes, such as electricity.
3. Luxury products: A luxury good does indeed have a demand elasticity of income greater than one. However, because luxury products are non-essential, purchasers’ purchasing habits remain sensitive.
4. To Properly Price Your Goods, Consider The Current Economic And Market Conditions

It is indeed important for your company to keep an eye on customer behaviour and changes in median household income. The more money they earn, the more money they have to spend on your items, therefore making market research a primary focus when determining your target audience’s revenue.

Conclusion

Organisations value the concept of national income because it aids them in determining where they should invest their income. Investors tend to invest in economies from which they can forecast that commodity demand is correlated to progress in national income and wherever income elasticity of demand is larger than zero.