Income Elasticity: Luxury Goods, Necessity Goods, and Inferior Goods.

 

Learning Contents:                                                            

·       Understanding Income Elasticity with respect of luxury goods, necessity goods and inferior goods.

The demand for a commodity not only depends on the price of a commodity but also the income level of the consumer. It is a general understanding that a consumer usually prefers to spend more when his income rises and less when his income falls. Sometimes, we might also experience a fall in the demand of certain goods and services even when income rises. Therefore, income elasticity varies with respect to different types of goods and services. The income elasticity measures the percentage change in quantity demanded as a result of percentage change in the income of the consumer. The formula of income elasticity of demand is,

The income elasticity measures the demand’s sensitivity or responsiveness to the change in income.  In simple words, it measures to what extent demand changes as a result of change in income. A highly income elastic demand for a good is when percentage change in quantity demanded is more than the percentage change in income. Whereas, a low income elastic demand for a good is when the percentage change in quantity demanded is less than the percentage change in income of the consumer. In his post will describe the nature and relationship of income with luxury, necessity and inferior goods.

Different types of goods and their relationship with income.

The relationship of income remains different with regard to different types of goods and services.  For example, the demand for necessity goods and luxury goods are positively related to the income of the consumer. The main difference lies between income elasticity of normal and luxury goods is with regard to the percentage of income spent on the consumption of these goods. Whereas, the demand for inferior goods is negatively related to the income of the consumer. A detailed explanation is given below:

1.Normal Goods

When the relationship between income and quantity demanded is positive, it is called a normal good. In other words, a normal good is one whose demand increases with increase in consumer’s income and vice versa. The income elasticity for the normal goods is positive. Normal good is further classified into luxury goods and necessity goods. It is also important to understand here is that “to what extent demand for a commodity changes as a result of change in income”.

1.1.Luxury Goods (Positive Relationship and High Income Elastic)

Luxury goods are a type of normal goods which are highly priced; superior goods purchased by the high income consumer group. These goods are not needed for the purpose of the survival. A consumer purchases in order to display his status and wealth in the society. These goods must possess two principal characteristics 1.Scarce and 2.High price. Such goods have very high positive income elasticity i.e. demand increases much more than the rate at which income increases. Purchase of premium cars, watches, wines, dining at high-end restaurants etc. are some examples of luxury goods. The income elasticity of demand for luxury good is more than unity or YED _LG > 1 as quantity demanded changes proportionately more than the proportionate change in income. Simply, when consumer spends more than what he earns is a luxury good. For example, if the demand increases by 25 percent while income increases by 20 percent, then the good is a luxury good because its income elasticity of demand is 1.25. An upward sloping flatter demand curve is drawn for the luxury goods.

1.2. Necessity Goods (Positive Relationship and Less Income Elastic)

Necessity goods are also the type of normal goods which are regularly purchased by consumers as part of their daily habit. Such goods are less sensitive to the change in income levels. In other words, they have low but positive income elasticity as their demand increases less than the rate at which income increases. These goods act as the necessities or survival for the consumers. Every day essentials like Milk, fruits, vegetables, water, electricity, gas, internet, medicines etc. are some examples of necessity goods and services. Like other normal goods, their demand also rises with rise in income but not at the rate at which income increases. Its income elasticity falls between zero and one or less than unity i.e. YED _NG < 1 as consumers will not increase his consumption on these goods at the same rate of their increased income level. Therefore, quantity demand changes proportionately less than the proportionate change in the income levels. For example, a consumer increases his spending on food by 30 percent while his income increases by 60 percent, then food will be considered as necessity good because its income elasticity of demand is 0.5.  An upward sloping and a steep demand curve is drawn for normal necessary goods.

2. Inferior Goods (Negative Income Elastic)

Inferior goods are the opposites of normal goods as their demand drops when consumer’s income rises and demand rises when consumer’s income decreases. Therefore, Inferior goods are negatively related to the income of the consumer. For example- A low income consumer would prefer to purchase off-branded clothes over the branded ones. A consumer generally shifts his purchase from low quality inferior goods to superior goods when income rises. As a result, the demand for inferior goods drops. On the other hand, a consumer buys more inferior goods when his income falls. As a result, the demand for inferior goods rises. The income elasticity for an inferior good is negative or less than zero and its coefficient is YED _IG < 0.

Fig 1: Engel Curves for Normal Goods, Luxury Goods and Inferior Goods

Explanation: The above figure 1 showing the relationship of income with normal necessity goods, normal luxury goods and inferior goods.  Here, Quantity demanded for different goods is shown on X-axis and income is shown on Y-axis.  Further, following observations are noted as below:

Necessity Goods: The upward sloping red-colored curve for necessity goods is steeper (Less elastic) as expenditure on necessity goods increases at a rate less than increase in income. When income rises from Y to Y_1, the quantity demanded also increases by a less quantity from Q to Q₁ (less quantity increased).

Luxury Goods: The upward sloping blue-colored curve for luxury goods is flatter (more elastic) as expenditure on luxury goods increases at a rate more than increase in income. When income rises from Y to Y_1, the quantity demanded also increases from Q to Q₂ (more quantity increased).

Inferior Goods: The downward sloping green -colored curve for inferior goods shows that consumer decreases the demand as a result of increase in his income. When income rises from Y to Y₁, the quantity demanded decreases from Q to Q₃ (quantity decreased).

 

Important Points to understand:

·   The difference between normal goods and inferior good is not only based upon their quality.

·   A consumer might like and an inferior good when his income is low may not like the same inferior good when his income is high.

·   The difference between these two goods is based on the likings and disliking of a consumer that changes with change in income. Therefore, no good is inferior at all times and for all.

Let’s try some questions

Choose the Correct Answer

1. If the income elasticity is greater than one the commodity is

a. Necessity 

b. Luxury

c. Inferior goods

d. None of these

2. If the income elasticity is less than one the commodity is

a. Necessity 

b. Luxury

c. Inferior goods

d. None of these

3. In case of inferior goods, income elasticity is:

a. zero

b. positive

c. negative

d. None of these

4. The income of a household rises by 20 per cent, the demand for computer rises by 25 per cent, this means computer (in Economics) is a/an

a. Inferior good

b. Luxury good

c. Necessity

d. can’t say

5. The income elasticity of demand is largest for

a. Food

b. Clothing

c. Shelter

d. Luxuries

6. An increase in kritika’s income decreases her demand for cassette tapes. For her, cassette tapes are

a. a normal good

b. an inferior good

c. a complement to any good

d. a substitute good

7. Goods whose income elasticities are positive are called

a. normal necessity goods

b. normal luxury goods

c. inferior goods

d. both a. and b.

8. Which of the following goods is probably the most highly income elastic?

a. salt

b. food

c. alcoholic beverages

d. private education

Answer Key

 

1.b	2.a	3.c	4.b
5.d	6. b	7. d	8. d

 

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