# Income Elasticity of Demand: Definition, Formula, and Types

## What Is Income Elasticity of Demand?

Income [elasticity](https://www.investopedia.com/terms/e/elasticity.asp) of demand measures how consumer demand for a specific good reacts to changes in [real income](https://www.investopedia.com/terms/r/realincome.asp). By examining this relationship using the formula—percent change in quantity demanded divided by percent change in income—one can discern whether a good is a necessity or a luxury. This concept is vital for businesses aiming to predict and respond to shifts in consumer purchasing behavior as income levels fluctuate.

### Key Takeaways

*   Income elasticity of demand measures how the quantity demanded of a good responds to changes in consumer income, indicating whether a good is a necessity or a luxury.
*   Goods with positive income elasticity are classified as normal goods, with necessity goods having an elasticity between zero and one, and luxury goods having elasticity greater than one.
*   Inferior goods have negative income elasticity, meaning as consumer income rises, the demand for these goods decreases.
*   A good with high income elasticity will see significant demand changes in response to income fluctuations, while inelastic goods maintain stable demand regardless of income changes.
*   Understanding income elasticity helps businesses predict sales changes during economic cycles, with luxury goods often seeing a significant demand drop during downturns.

![Income Elasticity of Demand](https://www.investopedia.com/thmb/erzYflbtOnny_9VQoRnNVavVui4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/IncomeElasticityDemand_Final_4194762-d43e702e8a384ec6beaddae86ac6a0e8.jpg)

*— Investopedia / Paige McLaughlin*

## How Income Elasticity of Demand Works

Income elasticity of demand measures the responsiveness of [demand](https://www.investopedia.com/terms/d/demand.asp) for a particular good to changes in consumer income.

A high income elasticity of demand means demand for the good is closely tied to income changes. Businesses assess income elasticity of demand to predict how [business cycles](https://www.investopedia.com/terms/b/businesscycle.asp) affect product sales.

### Differentiating Between Inferior and Normal Goods

Goods are classified as inferior or [normal goods](https://www.investopedia.com/terms/n/normal-good.asp) based on their income elasticity values. Normal goods have positive income elasticity, indicating that demand increases with rising incomes.

Necessity goods have income elasticity between zero and one, meaning people buy them regardless of income changes. Examples of necessity goods and services include tobacco products, haircuts, water, and electricity.

As income rises, the proportion of total consumer expenditures on necessity goods typically declines. [Inferior goods](https://www.investopedia.com/terms/i/inferior-good.asp) have a negative income elasticity of demand; as consumers' income rises, they buy fewer inferior goods. Margarine, being cheaper than butter, is a common example.

Furthermore, luxury goods are a type of normal good associated with income elasticities of demand greater than one. Consumers will buy proportionately more of a particular good compared to a percentage change in their income. Luxury goods like premium cars, boats, and jewelry are highly sensitive to income changes. When a business cycle turns downward, demand for [consumer discretionary](https://www.investopedia.com/terms/c/consumer-discretionary.asp) goods tends to drop as workers become unemployed.  

## Calculating Income Elasticity of Demand

The formula for income elasticity of demand is:

> $\begin{aligned}&\text{Income Elasticity of Demand} = \frac{ \frac { D_1 - D_0 }{ D_1 + D_0 } }{ \frac { I_1 - I_0 }{ I_1 + I_0 } } \\&\textbf{where:} \\&D_0 = \text{Initial quantity demanded} \\&D_1 = \text{Final quantity demanded} \\&I_0 = \text{Initial real income} \\&I_1 = \text{Final real income} \\\end{aligned}$

## Real-Life Example of Income Elasticity of Demand

Consider a local car dealership that gathers data on changes in demand and consumer income for its cars for a particular year. When the average real income of its customers falls from $50,000 to $40,000, the demand for its cars plummets from 10,000 to 5,000 units sold, all other things unchanged.

Calculate income elasticity by dividing the 50% decrease in demand by the 20% drop in income. This produces an elasticity of 2.5, which indicates local customers are particularly sensitive to changes in their income when it comes to buying cars.

## Exploring Different Types of Income Elasticity of Demand

There are five types of income elasticity of demand:

1.  **High:** A rise in income comes with bigger increases in the quantity demanded.
2.  **Unitary:** The rise in income is proportionate to the increase in the quantity demanded.
3.  **Low:** A jump in income is less than proportionate to the increase in the quantity demanded.
4.  **Zero:** The quantity bought/demanded is the same even if income changes
5.  **Negative:** An increase in income comes with a decrease in the quantity demanded.

## How Do You Interpret Income Elasticity of Demand?

Income elasticity of demand measures how demand changes with consumer income shifts.

Highly elastic goods will see their quantity demanded change rapidly with income changes, while inelastic goods will see the same quantity demanded even as income changes.

## What Does an Income Elasticity of Demand of 1.50 Mean?

Since the value is positive, the good is elastic. It implies that for every 1% increase in income, people will demand an increase of 1.5% in the number of goods. Thus, if the average income is $100,000 and at that level of income people desire 70 meals out a year, they would demand 71 meals a year if income rose to $101,000 (1.5% of 70=1.05 meals more).  

## How Does Income Elasticity of Demand Differ From Price Elasticity of Demand?

Price elasticity of demand measures the change in percentage of demand caused by a percent change in price, rather than a percent change in income.

## Can Income Elasticity of Demand Be Negative?

Yes, for example with certain "inferior" goods, the more money people have the less likely they are to buy cheaper products in favor of higher quality ones.

## What Is Something That Is Inelastic to Changes in Income?

Inelastic goods tend to have the same demand regardless of income. Certain staples and basics such as gasoline or milk would not change with income—you'll still only need one gallon a week even if your income doubles.

## The Bottom Line

Income elasticity of demand is the change in quantity demanded of a good or service in relation to the change in real income of a consumer who buys that good or service. It is a [primary variable in the causes](https://www.investopedia.com/ask/answers/040815/what-are-some-examples-demand-elasticity-other-price-elasticity-demand.asp) of price elasticity. Income elasticity of demand will denote whether a product is an essential item or a luxury item.

The higher the inelasticity of demand for a good or service, the more sensitive the demand for it is to fluctuations in consumer income. If a good or service has a high inelasticity of demand, it will experience a decline in demand when the real income of consumers decreases. If real income increases, it will lead to an increase in demand. If a good or service has a low inelasticity of demand, its demand will not significantly change regardless of what happens to the real income of consumers. Goods with low income elasticity have demand that doesn't change much with income shifts.

**_Correction—March 7, 2023:_** A previous version of this article incorrectly defined an income elasticity of demand of 1.5 in an example. It has been edited to reflect that an elasticity of demand of 1.5 refers to an increase of 1.5 in the percentage of the quantity demanded, not an increase of 1.5 units.