Income Elasticity of Demand (IED)

Introduction

• Concept: Examines how demand for products and services changes with income fluctuations.
• Key Question: How does demand shift when income increases by a significant percentage, e.g., 50%?
• Relevance: Important for marketers to understand consumer behavior in response to income changes.

Definition

• Income Elasticity of Demand (IED): Measures the responsiveness of demand to changes in income.
• Formula:
  • IED = % Change in Quantity Demanded / % Change in Income

Example Calculation

• Scenario:
  • Average Income: £20,000
  • Demand for Product X: 10 million units
  • Income rises to £22,000
  • Demand rises to 12 million units
• Percentage Change in Demand:
  • Calculation: (12 million - 10 million) / 10 million = 20%
• Percentage Change in Income:
  • Calculation: (£22,000 - £20,000) / £20,000 = 10%
• IED Calculation:
  • 20% (change in demand) / 10% (change in income) = 2

Interpretation

• Luxury Products:
  • IED > 1: Demand increases more than income increase.
  • Examples: Branded goods, luxury items.
• Necessities:
  • 0 < IED < 1: Demand increases but less than income increase.
  • Examples: Basic goods such as milk, generic products.
• General Outcome: As income increases, demand generally increases, but the extent varies.

Special Case: Inferior Goods

• Negative IED: Demand decreases as income increases, and vice versa.
• Consumer Behavior:
  • Switch to inferior goods when incomes fall.
  • Switch away from inferior goods when incomes rise.
• Example Context: Rise of discount retailers during recessions as consumers look for value-for-money options.

Conclusion

• Impact of Economic Changes: Income changes have a significant impact on demand, affecting different types of goods in various ways.
• Marketers' Consideration: Understanding IED helps predict consumer spending patterns and adjust marketing strategies accordingly.