Sunday  August 11, 2024
 AmosWEB means Economics with a Touch of Whimsy!
 ANNUITY: The receipt of payments at regular intervals from a established fund. Annuities are commonly used for insurance and retirement programs. It works in this way: A fund, which can be established either through a one-time sum of money or a series of payments, is exhausted over time with fixed, periodic payments. The amount of each payment depends on the interest accrued on the outstanding balance in the fund, and the length of time scheduled to exhaust the fund. For example, if your pension plan is based on an annuity that begins payments at the age of 65, then the size of the payments depends on whether you expect to live 5, 10, 15, or more years and set up payments accordingly. It's very similar to amortization, but in the reverse direction.

INCOME ELASTICITY OF DEMAND:

The relative response of a change in demand to a change in income. More specifically the income elasticity of demand is the percentage change in demand due to a percentage change in buyers' income. This notion of elasticity captures the buyers' income demand determinant. Three other notable elasticities are the price elasticity of demand, the price elasticity of supply, and the cross elasticity of demand.
The income elasticity of demand quantifies the theoretical relationship between income and demand identified by the buyers' income demand determinant. A positive income elasticity indicates a normal good and a negative income elasticity exists for an inferior good.

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

The income elasticity of demand is often summarized by this handy formula:
 income elasticityof demand = percentage changein demandpercentage changein income
In theory, the income elasticity is specified in terms of the "percentage change in demand." The reason is that buyers' income affects demand not quantity demanded.

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

Buyers' income affects the demand for a good in one of two basic ways. An increase in income causes either an increase or decrease in demand. The result is either a normal good or an inferior good.
AlternativeCoefficient (N)
Normal GoodN > 0
Inferior GoodN < 0
Superior GoodN > 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.
A normal good can also be classified as either elastic or inelastic, depending on the value of the income elasticity relative to 1. An inelastic normal good has a positive coefficient that is less than 1, 0 < N < 1. In contrast, an elastic normal good has a positive coefficient that is greater than 1, N > 1. This last case is commonly termed a luxury or superior good.
• 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.
Although some goods might intuitively appear to be normal, inferior, or superior goods, economists generally let income elasticity calculations make the actual determination. This is especially important in that a particularly good might be normal for one buyer, inferior for another, and superior for a third.

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

The income elasticity of demand is one of four common elasticities used in the analysis of the market. The other three are price elasticity of demand, price elasticity of supply, and cross elasticity of demand.
• 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.

 <= INCOME EFFECT INCOME RECEIVED BUT NOT EARNED =>

Recommended Citation:

INCOME ELASTICITY OF DEMAND, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: August 11, 2024].

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