Question

1. Explain the concept of income elasticity of demand. How is it used to identify normal goods, luxuries, necessities, and inferior goods? Be as specific and logical as possible.

Answer 1

Income elasticity of demand in simple terms gives the relationship between income of a consumer and the quantity of goods that he consumes.

It is calculated by the ratio of percentage change in the quantity demanded to the percentage change in the income of a consumer

If the value of income elasticity of demand is positive then the good can be classified under normal good

A normal good is that type of good in which when there is increase in the income, the quantity consumed by the consumer increases

When the value of income elasticity of demand is negative then the good can be classified under inferior goods

In inferior good, as the income rises the consumption of any good by the consumer decreases

When the value of income elasticity of demand is positive but less than 1 then the good can be classified under necessity good

Example of necessity good can be water, gasoline etc

If the value of income elasticity of demand is positive and greater than 1 then the good can be classified under luxury good

Example can be diamond necklace