Demand Elasticity in Regards to Income: Definition, Equation, Calculation Procedure
In times of economic crisis, consumer income often takes a hit, leading to a decrease in demand for luxury goods. This is because such goods are considered non-essential items, and when income drops, people tend to prioritize their necessities over indulgences.
However, it's important to note that demand for consumer goods can be inelastic, meaning changes in demand may not be as significant as changes in demand for luxury goods, ceteris paribus. This means that even during an economic downturn, some people may still have the means to purchase luxury items.
On the flip side, demand for inferior goods decreases when consumer income rises. Inferior goods, which are often lower-quality substitutes for normal goods, have a negative income elasticity of demand. This means that as income increases, the demand for inferior goods decreases because consumers tend to switch to higher-quality substitutes as their purchasing power improves.
The luxury goods business, on the other hand, sees increased demand during prosperous economies. Luxury goods have an income elasticity greater than 1, meaning that as consumer income rises, the demand for luxury goods increases more than proportionally. This reflects that luxury goods are non-essential items for which people spend relatively more when they become wealthier.
Goods with an income elasticity between 0 and 1 are considered normal necessities. This means that demand rises with income but less than proportionally compared to luxury goods.
To illustrate, cars can be a luxury item for low-income individuals, but a necessity for wealthy individuals. Rice, on the other hand, can be an example of an inferior good for someone with a certain income level. A smartphone might be a luxury for some individuals, but a necessity for others.
This relationship between income elasticity and the demand for luxury goods versus inferior goods helps businesses and economists predict how demand shifts with changes in consumer income levels. Understanding this relationship can provide valuable insights for businesses looking to adjust their strategies in response to economic changes.
References:
[1] "Income Elasticity of Demand" by Investopedia. Accessed on August 10, 2022. https://www.investopedia.com/terms/i/incomeelasticityofdemand.asp
[2] "Economics: Principles and Applications" by Greg Mankiw. 8th edition. Worth Publishers.
[4] "Microeconomics" by N. Gregory Mankiw. 9th edition. Cengage Learning.
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