What is meant by income elasticity of demand?

Income elasticity of demand is an economic measure that shows how sensitive the quantity demanded of a good or service is to changes in consumer income. In other words, it indicates the percentage change in the amount demanded of a particular product in response to a percentage change in income.

To calculate the income elasticity of demand, you can use the following formula: \(Income \, Elasticity \, of \, Demand (E) = \frac{Percentage \, Change \, in \, Quantity \, Demanded}{Percentage \, Change \, in \, Income}\) Where: - Percentage Change in Quantity Demanded = \(\frac{New \, Quantity \, Demanded - Old \, Quantity \, Demanded}{Old \, Quantity \, Demanded} \times 100\) - Percentage Change in Income = \(\frac{New \, Income - Old \, Income}{Old \, Income} \times 100\)

Depending on the sign and magnitude of the income elasticity of demand (E), we can classify products into different categories: 1. Normal Goods: a. Necessities (0 < E < 1): When the income elasticity of demand is positive but less than 1, the good is considered a necessity. As consumer income increases, the demand for these goods also increases, but at a slower rate. b. Luxuries (E > 1): When the income elasticity of demand is greater than 1, the good is considered a luxury. An increase in consumer income causes the demand for luxuries to increase at a faster rate. 2. Inferior Goods (E < 0): When the income elasticity of demand is negative, the good is considered an inferior good. As consumer income increases, the demand for these goods decreases.

Let's say the annual income of a household increases from \(50,000 to \)60,000, a 20% increase. The household's demand for a certain brand of clothing increases from 10 items to 12 items, a 20% increase as well. Using the income elasticity of demand formula: \(E = \frac{Percentage \, Change \, in \, Quantity \, Demanded}{Percentage \, Change \, in \, Income} = \frac{20\%}{20\%} = 1\) In this example, the income elasticity of demand for this brand of clothing is 1, which means the product is a normal good and can be considered a luxury. As the household's income increased, their demand for the clothing items also increased proportionally.