# Income Elasticity of Demand Calculator

*“Economics, Fifth Edition“*(2017)

- What is income elasticity of demand?
- The income elasticity of demand of normal and inferior goods
- Application of income elasticity of demand
- How do you calculate income elasticity of demand?
- How to use the income elasticity of demand calculator
- How to calculate income elasticity of demand example with steps
- Income elasticity of demand example in macroeconomics
- FAQ

The **income elasticity of demand calculator** (with steps) helps you **measure the effect of changes in consumers' incomes on demand** for a given good. It is measured as the **ratio of the percentage change in quantity demanded to the percentage change in income**.

Read further and learn the following:

**What is income elasticity**of demand;- How to
**find income elasticity of demand**- the income elasticity of demand formula; and - The
**application**of income elasticity of demand.

Moreover, we present a **practical example** to understand the macroeconomic intuition behind the income elasticity of demand.

## What is income elasticity of demand?

As you may know, **multiple factors can affect the quantity of a good demanded**. Its prices, for example, measured by the price elasticity of demand, is a prominent variable that can alter demand.

Another variable that can induce such changes by *shifting the demand curve* is the **income of consumers**. More precisely, the **income elasticity of demand measures how responsive the demand** for a good **is to changes** in consumers' **incomes**. We will say more about the formula for calculating the income elasticity of demand in the following paragraphs.

## The income elasticity of demand of normal and inferior goods

Like the cross-price elasticity of demand between two goods, the income elasticity of demand for a good can also be positive or negative.

The **sign of the income elasticity of demand reveals** whether a good is **normal or inferior**. On the one hand, the **good is normal** when the **demand increases when income rises**. On the other hand, a good is considered **inferior** when **demand decreases when income rises**.

To sum up:

- A
**positive income elasticity of demand**coefficient indicates that the good is a**normal good**: the quantity demanded at any given price increases as income increases. - A
**negative income elasticity of demand**coefficient indicates that the good is**inferior good**: the quantity demanded at any given price decreases as income increases.

Our income elasticity of demand calculator with steps shows you such a result interpretation after making the computations.

## Application of income elasticity of demand

While the income elasticity of demand for a normal good is always positive, its value **contains** further helpful **information**. Policymakers are often interested in *how a particular industry will grow as consumers' income increases* over time to support economic decisions promoting employment or economic growth. By determining whether the income elasticity of **demand for a good is larger or less than 1**, one can distinguish between *income-elastic* and *income-inelastic* goods.

The demand for a good is **income-elastic** if the **income elasticity of demand formula for that good yields more than 1**. It means that when income rises, the demand for **income-elastic goods** rises faster than income.

Luxury goods such as holiday houses, expensive cars and international travel are income-elastic examples.

The demand for a good is **income-inelastic** if the **income elasticity of demand is less than 1**. It suggests that when income rises, the demand for **income-inelastic goods** rises more slowly than income. Necessities such as food and clothes are typically income-inelastic.

## How do you calculate income elasticity of demand?

The **formula for calculating income elasticity of demand** is the following:

**Find**the change in quantity demanded.**Determine**the change in income.**Divide**the first value by the second:

**Income elasticity of demand = Change in quantity demanded / Change in income**

You can compute the percentage change in the quantity demanded ($x_1$) and income ($x_2$) in two different ways:

- With the
**standard way**of computation:

$\Delta x = (x_{i2} - x_{i1}) / x_{i1}$

- Calculate income elasticity of demand
**using midpoint method**:

$\Delta x = (x_{i2} - x_{i1}) / \lparen (x_{i1} + x_{i2})/2\rparen$

where:

- $\Delta x$ - Change in quantity demanded or income;
- $x_{i1}$ - Quantity demanded or income in period 1; and
- $x_{i2}$ - Quantity demanded or income in period 2.

## How to use the income elasticity of demand calculator

In the default mode of the income elasticity of demand calculator, you need to set the following **two parameters** to get the result for the income elasticity of demand:

- Percent change in income; and
- Percentage change in quantity.

You can also input **additional numbers** for periods 1 and 2 separately, and we also provide the option for choosing between the *standard* and the *midpoint method* of estimation:

- Method - by default, we use the standard approximation, but you can also calculate income elasticity of demand using the midpoint method;
- Income in period 1;
- Income in period 2;
- Quantity demanded in period 1; and
- Quantity demanded in period 2.

## How to calculate income elasticity of demand example with steps

Let's take a **simple example** to see how income elasticity of demand works. In the demand curve below:

- For the first period, while income was 1000, the quantity demanded was 100; and
- For the second period, when the income increased to 1200, the quantity demanded increased to 150.

So, the example of how to calculate income elasticity of demand is the following:

- Estimate the
**percentage change in quantity demanded**:

`Change in quantity demanded = (150 - 100) / 100 = 0.05 = 50%`

- Compute the
**percentage change in income**:

`Change in income = (1200 - 1000) / 1000 = 0.02 = 20%`

- Calculate
**income elasticity of demand**:

`Income elasticity of demand = Change in quantity demanded / Change in income = 0.05 / 0.02 = 2.5`

The result suggests that the income elasticity curve represents an *income-inelastic normal good*, such as foods or clothes.

## Income elasticity of demand example in macroeconomics

A practical way to demonstrate the relevance of the income elasticity of demand is to take a **real-world example**.

You may be able to envisage a picture of an American family living on a farm, but do you know **what portion of the population lives on a farm in the U.S.** nowadays? The figure is surprisingly low if we make a comparison over history. While in the 18th century, many Americans lived in the countryside and took part in agriculture, only about 1.3 % of the population does so in our times.

Why did this significant change happen? The income elasticity of demand gives the answer. Since **food demand is typically income inelastic** (its income elasticity of demand is much less than 1), as consumers' **income grew**, the **proportion of food** in a general basket of consumers' basket **became smaller**. Putting it on a macro scale, the **falling share of income** in the GDP spent on food means a **lower income share earned by farmers**. Moreover, the considerable *technological progress in the agrarian sector* triggered high competition between farmers, which depressed prices of agricultural goods, *ceteris paribus*, further reducing the total revenue of farmers.

To summarize, the **combination** of the **income elasticity of demand** of foodstuffs and the fast **technological progress** in agriculture explains the **relative decline of farming** in the United States.

## FAQ

### What are the factors that affect income elasticity of demand?

The main **factors which affect income elasticity of demand** are:

- The
**degree of necessity**of the good; - The
**level of income**of consumers; and - The
**rate**at which the**desire for the good is satisfied**as consumption increases.

### What is the importance of income elasticity of demand to the government?

By estimating the income elasticity of demand, economists can distinguish industries according to their **growth potential** when consumer income grows over time. Such information can help policymakers decide on possible interventions in the market.

### Can the income elasticity of a good be negative?

**Yes**. Negative income elasticity of demand coefficient **indicates** that the good is an **inferior good**: the quantity demanded at any given price decreases as income increases because people can now afford better quality equivalents.

### What is the income elasticity of demand for luxury goods?

Luxury goods typically have a **greater than one** income elasticity of demand, which means that their demand increases at a greater proportional rate than income.

For example, if the demand for expensive watches increases by 22 percent when aggregate income increases by 20 percent, then watches are considered **luxury goods** because they have an **income elasticity of demand of 1.1**.