Question

Explain income elasticity of demand? Discuss how can it be used to determine whether a good is a normal good or an inferior good?

Answer 1

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

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

Normal goods are the ones that have a direct relationship with the income of the consumers. Goods like food items, furniture, clothes, etc. The demand for these goods increases as the income of the consumers increases.

Inferior goods are the ones that have an indirect relationship with the income of the consumers. Suppose an employee who takes a bus to go to work gets a promotion and then he switches from bus to cab. The bus here will be considered as the inferior good since its demand decreased with the increase in income of the consumer.

From the above definitions and the formula of income elasticity, we can see that normal goods have a positive income elasticity and the inferior goods have a negative income elasticity.

OR

If the value of income elasticity is positive, then the good is called normal good and if the income elasticity of demand is negative, the good is called an inferior good.