Suppose, for example, that the average income of hot fudge sundae buyers in Shady Valley increases by 10 percent (say $20,000 to $22,000 per year). This increase in income is likely to cause the demand to change. The income elasticity of demand answers the questions: Does demand increase or decrease, and if so, by how much? If the demand increases by 10 percent (say from 100 hot fudge sundaes to 110 hot fudge sundaes), then hot fudge sundaes is a normal good. If the demand decreases by 10 percent (say from 100 hot fudge sundaes to 90 hot fudge sundaes), then hot fudge sundaes is an inferior good.

A Summary Formula

income elasticity of demand

=

percentage change in demand percentage change in income

However, in practice, the income elasticity of demand is calculated as the percentage change in "quantity" resulting from the percentage change income. In other words, the calculation is based on the change in quantity from one value to another.

Normal and Inferior

Alternative	Coefficient (N)
Normal Good	N > 0
Inferior Good	N < 0
Superior Good	N > 1

• Normal Good: A normal good exists if an increase in income causes an increase in demand. This is seen as a positive value for the income elasticity of demand, or a coefficient of elasticity of N > 0.


• Inferior Good: An inferior good exists if an increase in income causes a decrease in demand. This is seen as a negative value for the income elasticity of demand, or a coefficient of elasticity of N < 0.

• Superior Good: A superior good exists if a relatively small increase in income causes a relatively large increase in demand. This is seen as a positive value for the income elasticity of demand greater than 1, or a coefficient of elasticity of N > 1.

For example, precious Penelope Pumpernickel, a poor but precocious youngster, might consider hot fudge sundaes a superior good. Should she receive any extra income, she is likely to spend it all on this tasty treat. Duncan Thurly, a moderately middle-class person considers hot fudge sundaes a normal good. It is just one of the goods he buys on a regular basis, and will continue to do so with additional income. However, Winston Smythe Kennsington III, a well-known rich guy, probably considers hot fudge sundaes an inferior good. As his income rises, he buys fewer hot fudge sundaes, preferring instead to purchase expensive imported Belgium desserts.

Three Other Elasticities

• Price Elasticity of Demand: On one side of the market is the price elasticity of demand. This is the relative response of quantity demanded to changes in the price. It is specified as the percentage change in quantity demanded to a percentage change in price.


• Price Elasticity of Supply: On the other side of the market is the price elasticity of supply. This is the relative response of quantity supplied to changes in the price. It is also analogously specified as the percentage change in quantity supplied to a percentage change in price.


• Cross Elasticity of Demand: This is the relative response of demand to changes in the price of another good, or the percentage change in the demand for one good due to a percentage change in the price of the other good. This elasticity quantifies the other prices demand determinant.