What is Income Elasticity Of Demand?

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Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain good to a change in the real income of consumers who buy this good.The formula for calculating income elasticity of demand is the percent change in quantity demanded divided by the percent change in income. With income elasticity of demand, you can tell if a particular good represents a necessity or a luxury.

Definition

Income elasticity of demand refers to the sensitivity of the quantity demanded of a good to changes in the actual income of the consumers purchasing that good. The formula for calculating income elasticity of demand is the percentage change in quantity demanded divided by the percentage change in income. By using income elasticity of demand, one can determine whether a good is a necessity or a luxury.

Origin

The concept of income elasticity of demand originates from basic economic principles, first introduced by 19th-century economist Alfred Marshall. He identified the impact of income changes on demand as a crucial factor in understanding market dynamics while studying consumer behavior.

Categories and Features

Income elasticity of demand can be categorized into three types: positive income elasticity, negative income elasticity, and zero income elasticity. Positive income elasticity indicates that demand increases as income rises, typically associated with luxury goods. Negative income elasticity suggests that demand decreases as income rises, often seen in inferior goods. Zero income elasticity means that income changes have no effect on demand, usually applicable to necessities.

Case Studies

A typical case is Apple Inc.'s high-end products, such as iPhones and MacBooks. As consumer income increases, the demand for these products also rises, demonstrating positive income elasticity. Another example is Walmart's private label products, where demand might decrease as consumer income increases, showing negative income elasticity.

Common Issues

Common issues investors face when applying income elasticity of demand include misclassifying goods and overlooking market changes that affect elasticity. A common misconception is that all luxury goods have high income elasticity, but in reality, some luxury goods may exhibit lower elasticity due to market saturation.

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