What do you expect will happen of the demand for a normal good such as red meat if income increases?
In the case of a normal good such as red meat, an increase in income increases the demand for it. Income elasticity tells us something about the size of the increase.
For most products, most of the time, the income elasticity of demand is positive – that is, a rise in income will cause an increase in the quantity demanded. This pattern is common enough that these goods are referred to as normal goods.
A higher level of income for a normal good causes the demand curve to shift to the right, which means that the income elasticity of demand is positive.
How far the demand shifts depends on the income elasticity of demand.
A higher income elasticity means a larger shift of the demand curve for a given change in income.
The value of a positive income elasticity of demand is also an indication of whether a good is a necessity or a luxury good.
- If the income elasticity is smaller than 1 (the percentage change in income is greater than the percentage change in quantity demanded), the good is classified as a necessity or essential good.
- If the income elasticity is greater than 1 (the percentage change in income is smaller than the percentage change in quantity demanded, the good is classified as a luxury good.
Betty, the owner of a travel agency, is concerned about the low economic growth forecasts given by the Minister of Finance in his annual budget speech.
Her concerns are _______
It is justified since travel is a luxury good and as economic growth slows down, income slows down and the demand for travel slows down.
Estimates of the income elasticity of demand are used to predict which industries will grow most rapidly as the incomes of consumers grow or which industries will be most affected negatively when the economy goes into a recession.