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Unit 5: Elasticity of Demand

5.3 Income Elasticity Notes

The income elasticity of demand (e ) is similar to the concept of price elasticity of demand. Just
i
as price determines price elasticity, so does income, another determinant of demand, determine
income elasticity.
The income elasticity of demand is a numerical measure of the degree to which quantity demanded
responds to a change in income, other determinants of demand being kept constant.
For example, let there be two goods, clothing and salt. Let the consumers income increase by 5%.
Then the percentage change (increase) in quantity demanded would be different for clothing
and different for salt (the percentage increase in quantity demanded for clothing is likely to be
much higher than that for salt). Thus, clothing and salt are said to have a different income
elasticity of demand. Thus, for the same percentage increase in income (i.e., 5%) the percentage
increase in the quantity demanded for different goods is different. Income elasticity of demand
provides us with a numerical measure of this difference.

Thus, income elasticity of demand allows us to compare the sensitivity of the demand for
various goods for the same change in income. From the definition,

% change in quantity demanded
e =
i % change in income

The income elasticity of a commodity may be positive (the usual or likely case) or negative,
depending on whether the good is normal or inferior.
A normal good is one where a percentage increase in income ceteris paribus causes a percentage
increase in quantity demanded and vice-versa. Thus for normal goods (e.g., clothing, cigarettes)
income and quantity demanded vary in direct proportion ceteris paribus due to which the
income elasticity of demand is positive.
An inferior good is one where a percentage increase in income ceteris paribus, causes a percentage
decrease in quantity demanded and vice-versa. Thus for inferior goods (e.g., cheap whisky,
artificial jewellery, imitation shoes, etc.) income and quantity demanded vary in an inverse
proportion ceteris paribus due to which the income elasticity of demand is negative.
When e = 1, the good is said to have unitary income elasticity; when e > 1, the good is said to be
i i
income elastic, and so on. Remember when e is negative, the good is an inferior good.
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5.4 Cross Elasticity of Demand

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Caution The cross elasticity of demand (e ) is a numerical measure of the degree to which
c
quantity demanded of a good responds to changes in the prices of other commodities, the
other determinants of demand being kept constant.
Let there be two goods X and Y. If the price of Y changes (increases or decreases), this may have
an effect on the quantity demanded of good X. The concept of cross elasticity provides a numerical
measure of the percentage change in quantity demanded due to a change in price of other
commodities. It measure the degree to which quantity demanded is a function of the price of all
other commodities. From the definition,

% change in quantity demanded of good X
e =
c % change in price of good Y

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