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The sensitivity of the amount desired for a specific good to a change in consumers' real income who buy it, all other things being equal, is referred to as income elasticity of demand.

The income elasticity of demand measures the responsiveness of demand for a given well to variations in consumer income.

If a consumer's real income changes, the higher the income elasticity of demand in absolute terms for a given commodity, the larger the response in their purchase patterns. Businesses frequently assess the income elasticity of demand for their products to forecast the effect of a business cycle on product sales.

The percent change in quantity demanded divided by the percent change in income is the formula for estimating the income elasticity of demand. You can identify if a product is necessary, or a luxury based on its income elasticity of demands.

The income elasticity of demand is defined as the percentage change in quantity demanded divided by the percentage change in income.

How to calculate Income Elasticity of Demand

Income Elasticity of Demand = % Change in Demand / % Change in Income

- % Change in Demand = (Demand End – Demand Start) / Demand Start
- % Change in Income = (Income End – Income Start) / Income Start

Example,

Demand at the start of the period is 1,000 units and 2,000 units at the end of the period. In the same period, income increased from 4,000 to 5,000.

- % Change in Demand = (2,000 – 1,000) / 1,000 = 1,000 / 1,000 = 1
- % Change in Income = (5,000 – 4,000) / 4,000 = 1,000 / 4,000 = 0.25

Income Elasticity of Demand = 1 / 0.25 = 4

Therefore, income elasticity of demand is 4.

*Example: #1*

Consider the case where a consumer's income drops by 6%, from $4.62K to $4.90K. The demand for luxury goods has dropped by 15%. Must you compute the demand elasticity of income?

**Solution:** The following data can be used to calculate the income elasticity of demand.

- Change in Quantity Demanded as a Percentage: -15 Percentage
- Change in Real Income as a Percentage of GDP: -6%

The above formula may now be used to compute the income elasticity of demand for luxuries goods:

- Income Elasticity of Demand = -15% / -6%
- Income Elasticity of Demand = 2.50

The Income Elasticity of Demand will be 2.50, indicating that demand for luxury is positively related to actual income.

*Example #2*

OLA is a mobile application founded in India that allows consumers to book rides at their leisure and go anywhere, whether inter-city or intra-city. OLA uses the supply and demand idea, and the price adjusts depending on the number of booking requests. Suppose the number of bookings exceeds the number of available cabs. In that case, it has a contentious surge pricing feature that will use vast amounts of data on cab supply and booking requests to regulate the price in real-time and maintain equilibrium for each real-time.

In addition to this approach, they will temporarily raise pricing, resulting in decreased booking requests. According to a recent study, if a day's spare money is left more than 20%, one will opt for a price hike, resulting in a 28 percent increase in bookings.

Based on the information provided, you must calculate the income elasticity of demand.

The data for calculating income elasticity of demand is provided below.

- Change in Quantity Demanded as a Percentage: 28%
- Change in Spare Income as a Percentage of Total Income: 20%

As can be seen, when the consumer day's extra income is left with them, there is an increase in bookings.

The formula mentioned above can now be used to calculate the elasticity of cab demand:

- Income Elasticity of Demand = 28% / 20%
- Income Elasticity of Demand = 1.40

The Income Elasticity of Demand will be 1.40, indicating that demand and spare income have a positive relationship. As a result, riding in cabs is portrayed as a luxury good.

The income elasticity of used clothing is mostly negative.

In general, there are three ways of calculating the income elasticity of demand. These techniques are:

- Percentage method
- Point method
- Arc method

One of the most widely used methods for determining demand elasticity is the percentage method. Income elasticity is calculated using this method by comparing the change in quantity demanded of a commodity to the rate of change in income of the customers who desire that item.

Income elasticity can be mathematically represented as follows using this method:

Where,

ΔQ = change in quantity demanded = Q2 – Q1

Q1 = initial quantity demanded

Q2 = new quantity demanded

ΔY = change in income of the consumers = Y2 – Y1

Y1 = initial income of the consumers

Y2 = new income of the consumers

For example, the demand of quantity when the consumer's income was Rs 3000 was 30 units. When his income increased by Rs 2000, the amount of commodity demanded by him became 50 units. Here, the income elasticity of demand can be calculated as:

Since Ey = 1, this is an example of unitary income elasticity of demand, in which a change in the consumer's income equals a change in the commodity's demand.

One of the geometric ways for assessing the income elasticity of demand assignment help at any point on the income demand curve is the point technique.

In the case of normal goods, the income demand curve is upward sloping, but it is downward sloping in the case of inferior products.

The method for calculating income elasticity, on the other hand, is determined by the structure of the income demand curve.

A linear income demand curve for price elasticity can be calculated by:

Figure: Curve of Income Demand

If the income demand curve is non-linear, income elasticity can be computed by drawing a tangent at the desired point. Then, using the equation, income elasticity can be easily determined.

In the figure given above, we can see DD is a non-linear demand curve, and P is the point whose income elasticity is calculated. Thus, a tangent MN is drawn through the point P to X-axis. Then income elasticity is calculated as:

An arc method is a geometric approach for determining the income elasticity of demand between any two locations on a demand curve. While the 'point approach' is used to assess income elasticity at any point on an income demand curve, this approach quantifies income elasticity over a range of between two points.

AB is an arc on the income demand curve DD, and C is the mid-point of AB, as shown in the diagram. The following methods are used to calculate the income elasticity of demand at point C.

First, the average income, as well as the amount demanded, are calculated:

Then income elasticity is calculated by applying the formula.

Where,

ΔQ = change in quantity demanded = Q2 – Q1

Q1 = initial quantity demanded

Q2 = new quantity demanded

ΔY = change in income of consumer = Y2 – Y1

Y1 = initial income of consumer

Y2 = new income of consumer

In general, negative income elasticity of demand is associated with inferior goods, implying that rising earnings will decrease demand and possibly switch to luxury items. Normal products are associated with a positive income elasticity of demand. A boost in income will lead to an increase in demand in this scenario.

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