income+elasticity

by: Grant Knies
 * __Income Elasticity of Demand__**

Qx,M = (%ΔQx^d)/(%ΔM)
 * __Definition:__** The Income Elasticity of Demand measures the rate of response of quantity demanded due to an increase (or decrease) in consumer income. (Moffat, 2007) The formula for Income Elasticity of Demand is the percent change in quantity demanded of good X divided by the percent change in income. The formula for the Income Elasticity of Demand is defined mathematically by:

The higher income elasticity, the more sensitive demand for a good is to changes in income. High income elasticity suggests that when a consumer's income rises, consumers will purchase much more of that good. If price elasticity is low, it implies that a change in a consumer’s income has very little influence on demand. Negative income elasticity means that the good is inferior, and an increase/decrease in income would decrease/increase the demand for that good. Positive income elasticity means the good is normal., and an increase/decrease in income would increase/decrease the demand for that good.


 * __Application:__** There are many real world examples of income elasticity of demand being used to set strategy during all times of the economic cycle. Although income elasticity is one of the few variables companies do not have control over, it can be very beneficial for companies to know how the demand for their goods or services will be affected by greater economic prosperity or economic recessions. If a company knows the income elasticity of demand for its product, then that company will be better prepared to increase or reduce production given economic growth or decline. The following examples explore useful ways that income elasticity can be applied to real world situations.

The first example looked at finding the income elasticity of demand for internet users in OECD countries. (Goel, Hsieh, and Nelson, 2006) The income elasticity for the OECD countries was determined greater 1. Since income elasticity is greater than 1, the authors concluded that internet use is a normal good and is not considered a “necessity”. Further, the authors broke down internet users into two smaller groups, subscribers and users, and found that, “Income elasticity also seems smaller for users than for subscribers.” Knowing this, companies should expect to see a greater change in the demand for subscriptions when the level of consumer income changes.

Income elasticity of demand can also be applied to transitioning economies to help plan for future demand of utilities. Atakhanova and Howie (2007) found that income elasticity of demand for electricity in Kazakhstan is less than 1. Therefore, expenditures on electricity will grow less rapidly than consumer income. The authors research also compared income elasticity among three sectors; industrial, service and residential. Among the three sectors, the residential sector had the lowest income elasticity. Given this, electricity is more of a necessity for the residential sector than the industrial or service sectors. Having this information will allow, "...policy makers to evaluate effects of price changes on different consumers and obtain demand forecasts for capacity planning."

Another article examined income elasticity to determine if health care is a luxury or a necessity. (Yu and Hong, 2007) Although previous studies have found health care to be a luxury (income elasticity > 1), the authors found the income elasticity of health care in Taiwan to be 0.411. Where the previous studies implied that expenditures on health care would grow more rapidly than income, Yu and Hong suggest that expenditures on health care in Taiwan would grow at a slower rate than income. Thus, health care in Taiwan is considered a necessity and not a luxury.

Income elasticity for internet service was determined to be greater than 1. Given this which of the following is true? A. Expenditures on internet service grow less rapidly than income. B. Expenditures on internet service grow at the same rate as income. C. Expenditures on internet service grow more rapidly than income. D. None of the above Answer: C When income elasticity of demand is greater than 1, expenditures on that good grow more rapidly than income. When income elasticity is less than 1, expenditures on that good grow less rapidly than income.
 * __Multiple Choice Questions:__**

The internet service in OECD countries was determined to be a normal good. Given this, which of the following must be true? A. As income increases, demand for internet service decreases. B. As income increases, demand for internet service increases. C. As income decreases, demand for internet services increases. D. Both A and C. Answer: B. Demand for normal goods increase/decrease when consumer income increases/decreases.

The income elasticity of a good is 1.82. Given this, which of the following is true? A. The good is normal. B. The good is inferior C. Expenditures grow more rapidly than income D. A and C E. B and C Answer: D. The good is normal because income elasticity is positive, and expenditures grow more rapidly than income because income elasticity is greater than 1.

If a good is normal and consumer income decreases the demand curve will. A. Shift to the right B. Shift to the left C. Remain unchanged D. None of the above Answer: B. When consumer income decreases demand for normal goods will decrease and demand for inferior goods will increase.

If income elasticity for health care in Taiwan is 0.411 and consumer income rises by 5%, how will demand for health care in Taiwan be affected? A. Demand will increase by 0.08% B. Demand will decrease by 2.92% C. Demand will increase by 2.06% D. Demand will decrease by 2.06% Answer: C. Qx,M (%ΔQx^d)/(%ΔM), 0.411(%ΔQx^d)/(5), %ΔQx^d=(5)*(0.411), %ΔQx^d=2.055 or 2.06

Atakhanova, Z., and Howie, P. (2007)Kazakhstan. //Energy Policy//, 35(7), 3729-3743.
 * __References:__**

Goel, R., Hsieh, E., Nelson, M., and Ram, R. (2006). Demand Elasticity for Internet Services. //Applied Economics//, 38(9), 975-980.

Moffatt, M. (2007). //Income Elasticity of Demand//. About.com. Retrieved September 15, 2007, from the World Wide Web: http://economics.about.com/cs/micfrohelp/a/income_elast.htm

Yu, T., Hong, Y. (2007). Is Health Care Really a Luxury? A Demand and Supply Approach. //Applied Economics//, 39(9), 1127-1131.