Question

1. Explain the concept of income elasticity of demand and describe the two cases that determine whether it is positive or negative.

Answer 1

Income elasticity of demand is the responsiveness of change in quantity demanded due to a change in the income of the consumer. It is given by the following formula:

Income elasticity of demand = % change in quantity demanded / % change in income of the consumer

Income elasticity of demand is positive for 'normal goods' and it is negative for 'inferior goods'.

Normal goods are the ones for which an increase in income leads to an increase in the quantity demanded. For example demand for branded clothes, an increase in the income will lead to an increase in its demand.

On the other hand, inferior goods are the ones for which an increase in income leads to a decrease in the quantity demanded. For example, if a person travels through the bus daily to his office and one day his income increases, after that he will switch to a private taxi for going to the office and not the bus. This means bus here is an inferior good whose demand decreases with the increase in income.