Income Elasticity Of Demand

Income Elasticity of Demand

The Income Elasticity of Demand measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good. The coefficient of income elasticity of demand is determined with the formula: (% change in quantity demanded) / (% change in income) (McConnell & Brue).

Income elasticity of demand is used to see how sensitive the demand for a good is to an income change. The higher the income elasticity, the more sensitive demand for a good is to income changes. Very high income elasticity suggests that when a consumer's income goes up, consumers will buy a great deal more of that good. Very low price elasticity implies just the opposite. There are factors that affect price elasticity also:

1) Availability of substitutes, the more possible substitutes, the greater the elasticity.

2) Degree of necessity.

3) Proportions of the purchaser's budget consumed by the item, products that consume larger portions of a purchaser's budget tend to have a greater elasticity.

4) Time period considered, elasticity tends to be greater over the long run because consumers have time to adjust their behavior.

5) Permanent or temporary price change, a one-day sale will elicit a different response than a permanent price decrease.

When analyzing the demand for dairy products, two of the most important factors that need to be considered are the retail price and household income effects. If all other economic variables are constant, lower retail price or higher income levels will lead to the noticeable changes in the demand for dairy products.

References

Buchholz, T. (1996). From Here to Economy: A Shortcut