1.2.5 Income elasticity of demand

Question 1

what is income elasticity of demand?

Answer 1

measures the responsiveness of demand for a product to a change in real income

Question 2

real income

Answer 2

the amount by which average incomes have adjusted for inflation (prices rising)

Question 3

income elasticity of demand equation

Answer 3

= % change in quantity demanded / % change in real incomes

Question 4

income elasticity of inferior goods

Answer 4

negative income elasticity

Question 5

income elasticity of normal goods

Answer 5

positive income elasticity between 0 and 1

Question 6

income elasticity of luxury goods

Answer 6

positive income elasticity above 1

Question 7

what is the effect of changes in income on inferior goods?
(increase and decrease)

Answer 7

increase in real incomes = decrease in demand
(consumers stop buying cheaper substitutes)

decrease in real incomes = increase in demand
(consumers by cheaper goods to save money)

Question 8

what is the effect of changes in income on normal goods?
(increase and decrease)

Answer 8

increase in real incomes = increase at same rate/ slowly
(wealthy consumers are able to buy more of this type of product)

decrease in real incomes= decrease at same rate/ slowly
(consumers will slightly cut back on these goods)

Question 9

what is the effect of changes in income on luxury goods?
(increase and decrease)

Answer 9

increase in real incomes = increase in demand (fast)
(consumers spend more money on luxury items)

decrease in real incomes = decrease in demand (fast)
(people turn to cheaper substitutes)

Question 10

what affects income elasticity?

Answer 10

indulgences
-things we can easily live without are more sensitive to a change in income

necessities
-basic items that are almost essential are not as sensitive to a change in income

Question 11

why is income elasticity important?

Answer 11

-sales forecasting
(knowing the likely reaction means they can see if they have reliable data available)
-financial planning
(budgets and financial plans)
-product portfolio management
(have a range of products with different income elasticities)