In the second factor outlined above, we saw that if price increases while income
stays the same, demand will decrease. It follows, then, that if there is an
increase in income, demand tends to increase as well.
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The degree to which an
increase in income will cause an increase in demand is called income elasticity
of demand, which can be expressed in the following equation:
If EDy is greater than one, demand for the item is considered to have a
high income elasticity. If however EDy is less than one, demand is considered to
be income inelastic. Luxury items usually have higher income elasticity because
when people have a higher income, they don't have to forfeit as much to buy
these luxury items. Let's look at an example of a luxury good: air travel.
Bob has just received a $10,000 increase in his salary, giving him a total of
$80,000 per annum. With this higher purchasing power, he decides that he can now
afford air travel twice a year instead of his previous once a year. With the
following equation we can calculate income demand elasticity:
Income elasticity of demand for Bob's air travel is seven - highly elastic.
With some goods and services, we may actually notice a decrease in demand as
income increases. These are considered goods and services of inferior quality
that will be dropped by a consumer who receives a salary increase. An example
may be the increase in the demand of DVDs as opposed to video cassettes, which
are generally considered to be of lower quality. Products for which the demand
decreases as income increases have an income elasticity of less than zero.
Products that witness no change in demand despite a change in income usually
have an income elasticity of zero - these goods and services are considered