Income Elasticity: Definition, Formula & Example

Instructor: Tara Schofield

Tara has a PhD in Marketing & Management

Should you buy it or not? That's a common question consumers ask when facing purchases of non-essential or large ticket items. This lesson will explain how this question relates to a person's income.

What Is Income Elasticity?

Income elasticity is an economic term that explains the connection between the demand of a product and the income of the consumer. In other words, if a person's income goes up or down, his income elasticity impacts if he will purchase a product or not. As a result, companies must be aware of how their customers will react if their customers income changes.

Income elasticity has more of an impact on larger purchases or non-essential items. A consumer will likely still buy bread or eggs if her income changes. However, if her income goes down, she may not buy a new TV. Likewise, if she gets a raise, she may splurge for that larger TV that she's been wanting. Income elasticity of a TV purchase is high while the income elasticity of bread is very low.

How Is Income Elasticity Calculated?

The formula for calculating income elasticity is:

Income Elasticity of Demand = Percent Change in Quantity Demanded / Percent Change in Income

If your income goes up 10% and that changes your demand for a product by 15%, the calculation is:

Income Elasticity of Demand = 15% / 10%

Income Elasticity of Demand = 1.5

Example of Income Elasticity

A local furniture store offers patio furniture in summer. Because they have offered the furniture for the last 5 years and the sales have been consistent, the store expects they will sell the same amount of furniture this year as they did last year. However, at the end of the summer, they realize the sales were up 10% from last year.

As they analyzed the situation, they realized the most notable change was an overall pay increase at the local plant that hires a large percentage of their customers. In fact, pay amounts had increased an average of 5% from last year.

They realized that income elasticity had a lot to do with their patio furniture sales increasing. To see how solid the connection is between income and demand, we calculate the income elasticity below:

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

Income Elasticity = 10% / 5%

Income Elasticity = 2

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