Income Elasticity of Demand and Types

This area of microeconomics is not free from descending voices. Prof. Steven N.S. Cheung goes to the extent:

“For a good that is actually transacted in the market, a Giffen good cannot logically exist because someone will bid the price so high that the good will not be traded in the market.” 

However, this statement qualifies for some quick questions:

Why will ‘someone’ bid for Giffen goods if he has resources to transact so big?

Will he do it for his individual demand or a market demand?

Why does he not go for substitutes? Especially when he can trade the whole volume of the product?

Income vs Elasticity of Demand

Price elasticity of demand helps us to measure a change in demanded quantity with variation in price. However, the income elasticity of demand helps us to calculate demand sensitivity of a particular product with a change in income of a specific group of income.

This is such a fancy concept that communist economists take it as a measure of the misery of the working class in a society. But there is more than one income group in a given society. It is not like stacking blocks over each other but like stuffing smaller balloons inside larger ones.

Suppose your target consumers live in one income group. A few of them get a substantial increase in their income. They will increase demand for many goods. They shall also shift towards better substitutes of many goods immediately. They may change their preferences for some products very slowly.

For example, consumers from a particular income group are purchasing diamonds, bread, and water. Due to sudden destruction or war, their income is halved by tomorrow. What will they prefer to leave out of these three goods?

Diamonds….!

But they will never stop having water though they may change their preferences for substitutes of bread.

We can define income elasticity of demand as a percentage change in demand of a particular product due to change in income of your targeted customers. We may express income elasticity of demand as Yd.

Negative or Positive Elasticity of Demand

When demand for your product increases with increase in income of the consumers, it is a positive elasticity (Yd=+x). However, when the demand for your product decreases with increase in revenue, the elasticity is negative (Yd=-x).

Negative Income Elasticity of Demand

Negative values show that you are dealing with products which have superior substitutes. As soon as income of your targeted consumers rises they shift towards better substitutes.

There is nothing personal.

It is business!

Suppose tomorrow income of your targeted consumers for low-cost shoes increases 100%, how many of them shall continue purchasing your boots? The answer to the question can help you to make crucial business decisions.

The decrease in demand for your shoes shows a negative income elastic product.

Tobacco and alcohol are classic examples to see what impact is made on different brands and verities with a change in income of a population. Furthermore, staple foods (bread, vegetables and frozen foods), mass transport (bus and rail), pizza, beer, etc. also fall into this category.

Positive Income Elasticity of Demand

Positive income elasticity of demand has a close relation with normal goods. In such cases, the increase in income leads the consumers to increase their demand in different ratios. Luxury and sports cars, fine wines, top chocolates, smartphones etc. fall in this category. 

Interpretation of Values

This table is an attempt to simplify the concept of the income elasticity of demand and impact of change on different goods types: 

Value

Goods Type

Change in Demand

Income Elasticity Type

Illustration

Ey>1

Luxury or superior

Quick

High elasticity

10% increase in income results in 15% increase in demand

Ey<1

Necessary

Slow

Low elasticity

10% increase in income results in 5% increase in demand

Ey=0

Sticky Goods

No Change

Inelastic

10% increase in income make no change in demand

Ey=1

Unity Elastic

Proportionate

Unity elasticity

10% increase in income results 10% increase in demand.

Ey=-x

Inferior

Inverse

Negative elasticity

10% increase in income results in 5% decrease in demand