INCOME ELASTICITY OF DEMAND

WEEK SEVEN

INCOME ELASTICITY OF DEMAND

CONTENT

• Definition
• Types (Positive and Negative)
• Measurement of Income Elasticity of Demand

DEFINITION: Income elasticity of demand is the degree of responsiveness of quantity  demanded of a commodity to a little change in consumer’s income. That is, it measures how changes in income of consumers will affect the quantity of commodities demanded by such consumers.  

Mathematically, income elasticity of demand is expressed as:

% change in Quantity Demanded

% change in Income

When the percentage change in income brings about an equal change in the quantity demanded, then income elasticity is unit.

When the percentage change in income is greater than the percentage change in quantity demanded, income elasticity is less than unit, hence income is inelastic.

When the percentage change in quantity demanded is greater than the percentage change in income, then income elasticity is greater than unit, hence income elasticity is elastic.

TYPES OF INCOME ELASTICITY OF DEMAND

1. Positive Income Elasticity of Demand: is the type of income elasticity of demand in which an increase in income of consumer will equally lead to an increase in the quantity of commodity demanded. This is applicable majorly to normal goods.
2. Negative Income Elasticity of Demand: is the type in which an increase in income of consumers will lead to a decrease in the quantity of commodity demanded. This is applicable to inferior goods.

EVALUATION

1. Define income elasticity of demand.
2. State the formula for calculating income elasticity of demand.

Illustration: The table below shows the various income and demand for different commodities.

Income            Quantity Demanded

       #                            Kg

1. 20,000                     120
2. 36,000                       96
3. 40,000                     160
4. 44,000                     200
5. 45,000                     240
6. 47,000                     252 
7. a) Calculate the income elasticity between (i) A and B  (ii) C and D  (iii) E and F
8. b) What kind of good relationship is between (i) A and B (ii) C and D

SOLUTION

Income Elasticity of Demand      =    % Change in Quantity Demanded

                                      % Change in Income

(a)    Income Elasticity of Demand

i    Between A and B

    = 120– 96 x 100

                     120                                  = 0.25

    36000 – 20,000 x 1000   

          20,000

ii    Between C and D

    200 – 160 x 100

                   160                                            = 2.5

          44000 – 40,000 x 100   

         40,000

iii    Between E and F

      252   –    240    x 100

              240

                                                                    = 1.125

    47000 –  45000 x 100

        45000       

(b)   i.    Giffen goods or inferior good

1.   Normal goods

 It should be re-emphasized that positive income elasticity of demand is for ‘normal’ or ‘superior’ or ‘luxury goods’, whereas Negative income elasticity of demand is for ‘abnormal’, or ‘inferior goods.  

EVALUATION

1. What is income elasticity of demand?
2. Explain two types of income elasticity of demand

READING ASSIGNMENT

1. Comprehensive Economics Page 124 – 127
2. Fundamentals of Economics Page 227 – 236

GENERAL EVALUATION QUESTIONS

1. Explain five reasons why a joint stock company is preferable to a one-man business.
2. State the law of Diminishing returns.
3. Define Labour as a factor of production.
4. What are the factors affecting the size of a firm?
5. Distinguish between fixed and variable cost.

WEEKEND ASSIGNMENT

1. The responsiveness of demand to a change in income is the measurement of_______(a) arc elasticity of demand (b) cross elasticity of demand (c) income elasticity of demand (d) Price  elasticity of demand
2. Given the income of A and B as________ 

            Income        Quantity demanded  kg

        A    20,000        120

        B    36,000        96

The income elasticity between A and B is ________

    (a) 0.25     (b) 0.95       (c)  2.3      (d)  2.7

3. What kind of good is between A and B above?

    (a)  private good    (b)  public good   (c)  luxury    (d)  necessity

4. Given  income  C and D and quantity demanded as follows:

        Income        Quantity Demanded

        40,000        160

        44,000        200   

    Calculate the coefficient of income elasticity of demand 

    (a)  2.5     (b) 4.7    (c) 0.44     (d) 6.5

5.   When an increase in consumer’s income leads to a decrease in quantity demanded of a commodity, income elasticity of demand is…………? (a) indeterminable  (b) positive (c) constant (d) negative
6. Income elasticity of demand is negative for…………… (a) normal goods (b) competitive goods (c) inferior goods (d) complementary goods

SECTION B

1. Differentiate between normal goods and inferior goods

2. The table below shows the various incomers and demand for different commodities.

    Income     Quantity Demanded (kg)

A    10,000        60

B    18,000        48

C    20,000        80

D    22,000        100

E    22,500        120

F    23,500        126

(b)  Calculate the income elasticity between     (i) A and B (ii) C and D (iii) E and F

(b)  What kind of good is between : (i) A and B  (ii) C and D