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Micro Economics

Notes 4.3 Income Elasticity of Demand

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.

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 defi nition,
% 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 causes a percentage increase in
quantity demanded and vice-versa (assuming that all other factors are held constant). Thus,
for normal goods (e.g., clothing, cold drinks) income and quantity demanded vary in direct
proportion (assuming that all other factors are held constant) due to which the income elasticity
of demand is positive.
An inferior good is one where a percentage increase in income, causes a percentage decrease in
quantity demanded and vice-versa (assuming that all other factors are held constant). Thus, for

inferior goods (e.g., cheap wine, artificial jewellery, imitation shoes, etc.) income and quantity
demanded vary in an inverse proportion (assuming that all other factors are held constant) 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.
i
4.4 Cross Elasticity of Demand

The cross elasticity of demand (e ) is a numerical measure of the degree to which quantity
c
demanded of a good responds to changes in the prices of other commodities, the other
determinants of demand being kept constant.

Example: 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 defi nition,

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

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