Income Elasticity of Demand is basically a measurement of how responsive a rise in income influences the demand for a good or service. It’s also called elasticity.
The concept of elasticity was developed by Thomas Sargent, a professor at the University of Chicago and at the Harvard Business School. In his paper, “The Theory of Demand,” he wrote: “We believe that there are two main concepts in economics that are related to each other. One is the notion of demand power, the other is the notion of income elasticity.”
The theory states that a rise in income leads to increased consumption of goods and services. As a result, a decrease in income would lead to decreased demand for goods and services. The concept of income elasticity is similar to that of demand elasticity. However, the latter deals with the quantity of income a person or a group of individuals receives and the amount of income they would be willing to pay for the same amount of goods and services.
According to this theory, income elasticity is the measure of the effect of any rise in income on a particular type of good or service on the quantity of that good or service sold. If the value of the good or service goes up, then demand would go up as well. It’s also said that when the quantity of supply goes down, demand also drops. The concept is applicable in both case of increased demand and decreased supply.
Income elasticity is closely associated to demand because demand for a good or service changes when the quantity of that good or service increases. So, when an individual is provided with more income, he would want to buy more goods or services. This is how income elasticity works. A person’s income is increased and it will drive up demand for the same. This is the reason why there is an increased level of income, but a corresponding drop in demand.
Income elasticity of supply can be measured by the ratio of the price of an item to its value. An increase in the income of a group would mean that the cost of the good goes up. The more you earn, the more you will spend. -need to buy the same item.
On the other hand, the supply side, the concept of income elasticity describes the relationship between the amount of money people have and the number of goods and services they buy. When you earn more income, you have more money to buy things. And you may need to buy even more to keep pace with your needs. This is why you may find yourself with a lot of things to buy, yet no money left over.
Because of this relationship, the theory of elasticity can be used to determine how effective government policies are at increasing the demand side of the economy. It can help determine whether the government should introduce a minimum wage or a benefit for the needy to stimulate demand. Income and wealth may also affect the demand for goods and services. So, if the government provides a grant to stimulate demand, then the demand will rise or it will decrease if the government does not provide such a grant.
Another factor affecting income elasticity is the level of competition between businesses. Some goods and services are relatively cheaper than others. If they are sold at cheaper prices, more people would buy them. If the demand for the good is high, the price of the good will also increase and the quantity of it available will go up.
Economic theory states that income elasticity is caused by the following factors: the amount of competition, the number of consumers, and the level of education of consumers. This is why certain industries will have more demand and higher income. than others. Therefore, if a country’s economy has a relatively low level of demand and the high level of education, income and wealth will be lower.
Income elasticity also affects the demand for some goods. If the demand for a particular good is high, the supply of that good will be limited. However, if there are many products in the market, the price will be higher than that for the same goods at a lower demand, therefore reducing the supply and increasing the demand.