Financing and Marketing Management

Unit 11 - Elasticity

11.3. Income elasticity of demand
Income elasticity of demand measures the percentage change in demand caused by a percent change in income. It is a measure of responsiveness of potential buyers to change in income. It shows how the quantity demanded will change when the income of the purchaser changes, the price of the commodity remaining the same. It may be defined thus: The Income Elasticity of demand for a good is the ratio of the percentage change in the amount spent on the commodity to a percentage change in the consumer’s income, price of commodity remaining constant. Thus,

Income Elasticity = Proportionate change in the quantity purchased

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Proportionate change in Income

while prices remain constant. It is equal to unity or one when the proportion of income spent on good remains the same even though income has increased. It is said to be greater than unity when the proportion of income spent on a good increases as income increases
It is said to be less than unity when the proportion of income spent on a good decreases as income increases. Generally speaking, when our income increases, we desire to purchase more of the things than we were previously purchasing unless the commodity happens to be an “inferior” good. Normally, then, since the income effect is positive, income elasticity of demand is also positive.
It is zero income elasticity of demand when change in income makes no change in our purchases, and it is negative when with an increase in income, the consumer purchases less, e.g., in the case of inferior goods. It may be carefully noted that for any individual seller or firm, the demand for the product as a whole may be inelastic. By lowering the price, as compared with his rivals, the seller can infinitely increase the demand for his product. The demand curve will thus be a horizontal line
Elasticity, viz., price elasticity and income elasticity, are valuable aids in the measurement of demand for different commodities. As such they are also helpful in measuring the incidence of taxation.