Measuring Income Elasticity of Demand: Proportionate Method

 

 Learning Contents:                                                            

·         Introduction to Income Elasticity of Demand

·         Measuring Income Elasticity using Proportionate Method

Introduction

Demand for the commodity is not only influenced by the price. Besides price, other factors such as the price of related goods, the income of the consumer, taste and preferences and expectations about the future price, etc. also influence the demand for the commodity. Therefore, the concept of elasticity of demand can be defined as a degree of change in demand for a commodity as a result of the change in its own price of the commodity, change in the price of related goods i.e. substitute goods and complementary goods, change in income of the consumer, etc. In this post, we will understand how income elasticity of demand is calculated using proportionate method.

Income Elasticity of Demand (Proportionate or Percentage Method)

Income elasticity of demand tells us the relationship between income and the quantity demand for the commodity. The effect of income on the demand for a commodity is measured by the income elasticity of demand. Therefore, it measures the percentage change in quantity demand in response to a percentage change in the income of the consumer. It is measured by its coefficient EY.  Mathematically, it is calculated as,













Here,

EY = Income Elasticity of Demand

Y= Initial Income; Y1= New Income;

Q= Initial quantity; Q1 = New quantity;

ΔY= Change in income; ΔQ= Change in quantity.

Measuring Income Elasticity: Proportionate Method or Percentage method

1. Suppose, a consumer’s monthly income is ₹1000 and he demands 10 units of a commodity. If his monthly income rises to ₹2000, his demand for the commodity also increases to 30 units. What will be his income elasticity of demand?

Solution:

Following information is given:

 

Q = 10 units

 

Q1= 30 units

 Î”Q =Q1-Q

       =30-10

       =20

 

Y = ₹ 1000

 

Y1= ₹2000

ΔY = Y1-Y

     =2000-1000

     = 1000

       

                              EY=?

 










Interpretation:

The calculated value of Elasticity of demand (EY) is 2 indicates more than unitary income elastic demand. It implies that 1% increase in income of the consumer caused 2% increase in its demand showing that change in demand is greater than the change in income.

2. Kabir’s income has increased from ₹940 per week to ₹1,060 per week. As a result, he decides to spend 9 percent more on entertainment per week. The income elasticity of Kabir’s demand is

Solution:

Following information is given:

 

     Percentage increase in the demand =9%

 

 

Y = ₹ 940

 

Y1= ₹1060

   ΔY = Y1-Y

     =1060-940

     = 120

% change in income = ×100

= 120/940×100

= 12.76%

 

EY=?

 








Interpretation:

The calculated value of Elasticity of demand (EY) is 0.7 indicates less than unitary income elastic demand. It implies that 1% increase in income of the consumer caused 0.7% increase in the demand showing that change in demand is less than the change in income.

3. Suppose that the weekly income of a household decreases from ₹1200 to ₹1000 and the quantity demand for soda cans falls from 18 to 14 units per week. Calculate income elasticity of demand.

Solution:

Following information is given:

 

Q = 18 liters

 

Q1= 14 liters

 Î”Q =Q1-Q

       =14-18

       = - 4

 

Y = ₹ 1200

 

Y1= ₹1000

ΔY = Y1-Y

     =1000-1200

     = - 200

 

EY=?

 

 










Interpretation:

The calculated value of income elasticity of demand (EY) is 1.33 indicates more than unitary income elastic demand. It implies that 1% decrease in income of the consumer caused 1.33% decrease in its demand showing that change in demand is greater than the change in income. 

4. Suppose a consumer’s income rises from Rs. 1000 to Rs. 1200, his purchase of the good X (say, rice) increases from 25 kgs per month to 28 kgs. What will be his income elasticity of demand for rice is:

Solution:

Following information is given:

 

Q = 25 kgs

 

Q1= 28 kgs

 Î”Q =Q1-Q

       =28-25

       = 3

 

Y = ₹ 1000

 

Y1= ₹1200

ΔY = Y1-Y

     =1200-1000

     = 200

       

EY=?

 

 










Interpretation:

The calculated value of income elasticity of demand (EY) is 0.60 indicates less than unitary income elastic demand. It implies that 1% increase in income of the consumer caused 0.6% increase in its demand showing that change in demand is less than change in income.

5. Suppose the income of the consumer increases by 50% and demand for the commodity increases by 20%. What will be the income elasticity of demand for commodity-X?

Solution:

Following information is given:

 

     Percentage increase in demand =20%

 

 

      Percentage increase in income =50%

       

EY=?








Interpretation:

The calculated value of income elasticity of demand (EY) is 0.40 indicates less than unitary income elastic demand. It implies that 1% increase in income of the consumer caused 0.4% increase in the demand showing that change in demand is less than change in income.

6. If income increased by 10%, the quantity demanded of a product increases by 5 %. Then the coefficient for the income elasticity of demand for this product is:

Solution:

Following information is given:

 

     Percentage increase in demand =5%

 

 

      Percentage increase in income =10%

 

EY=?

 








Interpretation:

The calculated value of income elasticity of demand (EY) is 0.50 indicates less than unitary income elastic demand. It implies that 1% increase in income of the consumer caused 0.5% increase in the demand showing that change in demand is less than change in income.

Let’s try some questions

Choose the Correct Answer

1. Which of the following describes best about Income Elasticity of demand?

a. Responsiveness of demand for a product to change in its own price.

b. Responsiveness of demand for a product to change in consumer’s income.

c. Responsiveness of demand for a product to changes in the price of some other product.

d. None of above.

2. The income elasticity of demand is the percentage change in

a. income divided by the percentage change in price.

b. the quantity demanded divided by the percentage change in income.

c. the price divided by the percentage change in income.

d. income divided by the percentage change in quantity demanded.

3. The income elasticity of demand for jewelry is 2. Other things equal, a 10 percent increase in consumer income will:

a. decrease the quantity of jewelry purchased by 20 percent.

b. increase the quantity of jewelry purchased by 10 percent.

c. decrease the quantity of jewelry purchased by 10 percent

d. increase the quantity of jewelry purchased by 20 percent.

4. A 10 percent increase in income has caused a 5 percent decrease in the quantity demanded. The income elasticity is

a. 0.5

b. -2.0

c. 2.0

d. -0.5 

                Answer Key

1.b

2.b

3.d

4.d

 

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