Income Elasticity of demand (IED)

Definition
Per (Gans et al.), income elasticity of demand measures how much quantity demand of a good responds to a change in consumers’ income.

Why It Matters
One reason elasticity is important to understand is that it helps to predict consumer’s behaviour. This helps businesses or governments with their pricing strategies.

Example
Normal goods have positive income elasticity (>0) (eg.: income rise = demand rise, vice versa)
Inferior goods have negative income elasticity (<0) (eg.: income rise = demand falls, vice versa)
Among normal goods:
Goods consumers regard as necessities are income inelastic (IED<1)
Goods consumers regards as luxuries tend to be income elastic (IED >1)

Limitation
One limitation of elasticity, per “Price Elasticity - the Decision Lab” (2025), is it assumes consumers are rational, which is the biggest criticism of economics. Reality isn’t black and white, instead it’s shaped by cognitive biases, emotions, and context.
For example, our willingness to pay shifts with expectations and how we frame value in the moment, like how it feels to pay $7 for a coffee in the morning and then paying $7 for a cocktail at night.

Work cited:
Gans, Joshua, et al. Principles of Microeconomics. South Melbourne, Victoria, Australia, Cengage Learning Australia, 2021.

“Price Elasticity - the Decision Lab.” The Decision Lab, 2025, thedecisionlab.com/reference-guide/economics/price-elasticity.