Income elasticity of demand is the responsiveness of DEMAND for a good or service to changes in INCOME. As consumer income rises, the demand for most goods and SERVICES will increase. For example, the demand for new cars and homes is quite sensitive to changes in income. Manufacturers of these PRODUCTs incorporate estimates of changing income when forecasting demand and making long-term planning decisions. Income elasticity of demand is calculated as follows:

Ey = (% change in demand for good X) /
(% change in income)

In the 1990s Americans’ income rose steadily, and demand for most products also increased. If income rose 4 percent and demand for a product increased 6 percent, the income elasticity of demand would be .06/.04 = 1.5. If, as one source states, the income elasticity of demand for automobiles were 1.7, then with a 4 percent increase in income, demand would be expected to increase by 6.8 percent (.04 x 1.7). Economists call goods for which an increase in income results in an increase in demand “normal” goods. There are also goods for which an increase in income will result in a decrease in demand; economists call these “inferior” goods. The label has nothing to do with the quality of the product or service, just the fact that they have negative income elasticity. The classic “inferior” good is potatoes. However, as consumers’ incomes rise, people substitute stuffing, gourmet rice, and other starches for potatoes. When consumers’ incomes decline, they purchase more potatoes. Another example comes from a very shrewd independent automobile mechanic. He observed that as the economy boomed, demand for his repair services declined, since people were buying new cars, trading in their “clunkers” and not creating work for him. But when the economy slowed, demand for his services increased as people held on to their cars longer. Since income tends to change slowly, most managers do not consider income elasticity of demand in daily or operational plans but do incorporate the impact of changing incomes in their STRATEGIC PLANNING. Some examples of estimated income elasticity include

movie tickets 3.4
foreign travel 3.1
wine 1.6
beef 0.5
beer 0.4
lard –0.1