Ch10 - income elasticity

• Income elasticity of demand

  The responsiveness of demand to a change in income
• Necessities

  Basic goods that consumers need to buy
• Income inelastic

  Value of income elasticity of demand is between +1 and -1
• Income inelastic goods

  • food
  • electricity
  • water
• Luxury goods

  Goods that consumers like to buy if they can afford them, spending on these goods is called discretionary expenditure - non-essential spending
• Income elastic

  Value of income elasticity of demand is greater than 1 or less than -1
• Income elastic goods

  • air travel
  • satellite TV
  • designer clothing
• Normal goods

  Increase in income results in increase in quantity demanded, income elasticity is positive
• Inferior goods

  Increase in income results in decrease in quantity demanded, income elasticity is negative
• Price elasticity

  Can provide useful information for businesses, can help firms predict the effect of a price change on total revenue
• Indirect taxes

  Government often raise revenue by imposing indirect taxes such as valued added tax and excise duty on products, PED values can allow the government to have more accurate estimate of the impact of intervention
• Indirect tax imposed on a good with inelastic demand


  Leads to a relatively small decrease in quantity demanded, so it would be an effective way for the government to generate tax revenue
• Subsidies

  Government may consider PED when granting a subsidy to producers, the effect of a subsidy is to move the supply curve to the right (i.e. to increase the supply)
• If the subsidy is designed to help the poor by making the good cheaper, and demand is price inelastic

  An increase in supply will only reduce the price slightly
• Income elasticity and business

  Many firms will be interested in income elasticity of demand, because changes in income in the economy may affect demand for their products
• If the economy is expanding or booming, income will increase

  Consumers will buy more normal goods and especially luxury goods, business may then focus more of their resources into producing luxury goods to gain more profit
• If the economy is not performing well (recession), producers may

  Produce more inferior goods, fearing that consumers' income may fall