The main determinants of income elasticity of demand

1 Nature of the need the good covers: It is seen that the percentage of income spent on food declines as the level of income increases. This is known Engel’s law.

It is noticed that for a normal good, increase in income, other things remaining the same, is associated with increase in the quantity of goods purchased. A good whose income elasticity is greater than one is called is luxury good. Foreign travel, in fact, has an estimated elasticity of about 3, indicating that it can be considered as a luxury good. Goods with income elasticities between zero and one are considered necessities. On the other hand, a negative elasticity of demand implies an inverse relationship between income and the amounts of goods purchases. Goods with negative income elasticities are those that consumers will eventually stop buying as their income increases.

2 The initial level of income of a country: This means to say that depending on the level of development of country different goods is categorized into luxury or necessary items. E.g., a TV set is a luxury item in an underdeveloped country whereas it is a necessity in a country with high per capita income.

3 Time period: Consumption’s patterns generally adjust with a time-lag to changes in income. It is seen that consumers adjust to rising income at a faster rate than to falling incomes, with respect to their consumption practices.

It is seen that since a consumer is associated to a high MPC (marginal propensity to consume) it becomes very difficult for him/her to decrease the same overnight, due to falling incomes. However, the case is just the opposite when an increase in the income takes place. In this case, the consumer can increase his MPC even without any lag of time. This implies to say that, it is always difficult for the consumer to adjust himself/herself to falling incomes that to rising incomes.

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