Income Elasticity of Demand(1)

8/2/2019 Income Elasticity of Demand(1)

1/14

Income Elasticity of DemandPresented to: Dr. Alam Raza

Group Members: M. Mickyel Khaliq - 8700Sadia Abdullah 8698

Abdul Wajid Chottani - 8706

M. Amir Shahid -


2/14

Income Elasticity of Demand Income elasticity of demand measures the

relationship between a change in quantitydemanded for good X and a change in real income.

How sensitive is the demand for a product to achange in the real incomes of consumers? We useincome elasticity of demand to measure this.

The results are important since the values of income

elasticity tell us something about the nature of a

productand how it is perceived by consumers.


3/14

How to calculate..

Income Elasticity of Demand / Ei

Ei=

Percentage change in quantitydemanded

Percentage change in income


4/14

Income Effect

The income effect is the change in the

quantity demanded of a good because

the change in its price has the effect of

changing a consumers real income.

Real income is the purchasing power

of a worker in terms of good and

services.

If the prices of goods and services

increase, the purchasing power of

workers will decrease.


5/14

Income Elasticity for Normal Goods

Normal goods have apositive income elasticity of

demand so as consumers

income rises, so more is

demanded at each price level

i.e. there is an outward shift

of the demand curve.

As incomes fall, less is

demanded at each price.


6/14

Necessities have an income elasticity ofdemand of between 0 and +1. Demandrises with income, but less thanproportionately.

This is because we have a limited needto consume additional quantities of

necessary goods as our real livingstandards rise.

The examples of this would be thedemand for fresh vegetables,toothpaste and newspapers.

If income increases by 10% and thedemand for fresh fruit increases by 4%then the income elasticity is +0.4.Demand is rising less thanproportionately to income.

Income Elasticity for Necessities


7/14

Income Elasticity for Luxury Goods

Luxuries have an incomeelasticity of demand > +1i.e. the demand rises morethan proportionate to achange in income for

example a 8% increase inincome might lead to a 16%rise in the demand forrestaurant meals. Theincome elasticity of demand

in this example is +2.0.Demand is highly sensitiveto (increases or decreasesin) income.


8/14

Income Elasticity for Inferior Goods

Inferior GoodsInferior goods have a negative incomeelasticity of demand.

Demand falls as income rises.

Typically inferior goods or servicestend to be products where there are

superior goods available if theconsumer has the money to be able tobuy it.

As income falls the demand for inferiorproducts might actually grow.

For example if we find that the incomeelasticity of demand for cigarettes is -0.3, then a 5% fall in the average realincomes of consumers might lead to a1.5% fall in the total demand forcigarettes (ceteris paribus).

Ei of cigarettes= % demand

% income

-0.3= 1.5/5


9/14


10/14

Income Elasticities For Several Products

-1

-0.5

0

0.5

1

1.5

2

2.5

3

Commodities


11/14

Summary Of The Graph

Income elasticities are high for luxuries, whose

consumption grows rapidly as income grows.

Negative income elasticities are found for inferiorgoods, whose demand falls as income rises.

Demand for many staple commodities, like clothing,

grows proportionately with income.


12/14

Long-term Affects on Income Elasticity

Long-term changes: There is a general downwardtrend in the income elasticity of demand for many

products, particularly foodstuffs.

One reason for this is that as a society becomes richer,there are changes in consumer tastes and preferences

about different goods and services.

What might have been considered a luxury good

several years ago might now be regarded as a necessity

(with a lower income elasticity of demand).


13/14

For example the marketfor foreign travel.

A few decades ago, long-distance foreign travelwas regarded as a luxury.Now as real price levels

have come down andincomes have grown,millions of consumersare able to fly overseas

on short and longerbreaks.


14/14

Substitution Effect On Elasticity

Elasticities aregenerally high for

goods for which

ready substitutes are

available, like

tomatoes or peas.

Low price elasticities

exist for those goods

like electricity which

are essential to daily

life and which have

no close substitutes.

0

0.5

1

1.5

2

2.53

3.5

4

4.5

5

Elasticity

Income Elasticity of Demand(1)

Documents

Transcript of Income Elasticity of Demand(1)