Income Elasticity of Demand

Demand is also likely to be responsiveness to factors other than ‘own price’ or the price of complements and substitutes. One important factor is real income (i.e., nominal income adjust for inflation). Empirical studies usually defined nominal income in term of either household disposable income (i.e., household income after income tax and other direct taxes, plus welfare state payments have been incorporated) or gross national income. Income elasticity of demand is defined as:
                        

    
1. Inferior goods: These are good of which consumers buy less when real income rises. The value of income elasticity is, therefore, negative. Example might be potatoes, lade cars, cheap package holidays, etc.
    
2. Normal Goods: These are the most common goods with demand generally rising as real income rise. They can themselves be further subdivided into two categories:
    
(a) Necessities: These are goods and service which exhibit a positive income elasticity of demand, though the value will tend to be less than 1. Articles such as basic foodstuffs and ordinary day-to-day clothing fall into this category. Consumers will purchase a certain amount of these goods at very low levels of income, but for any given percentage increase in real income they will tend to increase their spending on the goods by a smaller proportion.
    
(b) Luxuries: At very low income levels, nothing will be spent on these but, once a certain threshold level is reached, the  proportionate rise in a demand for luxury goods is greater than the proportionate rise in demand for luxury goods is greater than the proportionate rise in real income, e.g., foreign holidays, eating out and video recorders.

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