INCOME ELASTICITY OF DEMAND

The responsiveness of quantity demanded to changes in income is called income elasticity of demand. With income elasticity, consumer incomes vary while tastes, the commodity’s own price, and the other prices are held constant. 
The income elasticity of demand for a good or service may be calculated by the formula:
ey = Percentage change in quantity demanded/ Percentage in income
                                ey = ∆Q/Q . ∆Y/Y = Y/Q. ∆Q/ ∆Y
where, ey stands for the coefficient of income elasticity , Y for income

• Whereas price-elasticity of demand is always negative, income-elasticity of demand is always positive (except inferior goods) as the relationship between income and quantity demanded of a product is positive. 
• For inferior goods the income elasticity of demand is negative because as income increases, consumers switch over to the consumption of superior substitutes. 
• The degree of income elasticity varies in accordance with the nature of commodities. In case of all normal goods, the income elasticity is positive. 
• For essential goods, the income elasticity is less than one. The quantity demanded increases less than proportionately as income increases. Soap, salt, match, newspapers have low income- elasticity of demand.
• For goods of comfort, the income-elasticity coefficient is equal to unit which results in proportionate change in quantity demand. 
• Luxury goods have income elasticity greater than unity implying more than proportionate change in quantity demanded. Jewelry, automobiles are goods of this category. 

Income elasticity of demand can be useful in the following business decisions.

1. Income-elasticity can be helpful in production planning and management in the long run, particularly during the period of business cycle.
2. It can be used for demand forecasting with given rate of increase in income.
 
Income Sensitivity: 

The income elasticity of demand measures the degree of responsiveness of physical quantities of consumption of a good as income changes. If we measure consumption by consumer expenditures rather than by physical quantities of a good, the phenomena may be described as income sensitivity. Income- sensitivity may be defined as the percentage change in expenditures on a good divided by the percentage change in income of the consumers. 

The Ys = Percentage change in expenditures/ Percentage change in income.
Ys = Percentage change in expenditures/ Percentage change in income,Ys= ∆R/E / ∆ Y/Y
 
Where, Ys measures the income sensitivity, DR measures change in consumer expenditure, DY measures change in income
Suppose a 10 percent increase in income causes consumer expenditure on a good to increase by 12 percent, the income sensitivity of that good is 1.2.