When considering the income elasticity of demand principle, it is important to understand two things:
- The equation to derive the income elasticity of demand.
- What the sign of the income elasticity of demand means.
The equation for deriving the income elasticity of demand is very similar to the equation for the price elasticity of demand. Instead of having percent change in quantity over percent change in price, we have percent change in quantity over percent change in income, or
% Change in Q / % Change in I = IEoD
So if the % change in both quantity and income is positive, then the sign of the whole equation is positive. In this case, we would have a normal good. However, if the percent change in quantity is negative while the percent change in income is positive, then the sign of the whole equation would negative and we would have an inferior good.
Consider the demand for a California criminal lawyer. Generally lower income individuals need criminal lawyers so we could assume that the income elasticity of demand measure for a criminal lawyer would be negative. This means that as one’s income goes down, the quantity demanded of criminal lawyers would rise.
However, if we looked at the market for criminal defense attorney in los angeles we may see a different story. Since Los Angeles has a lot of celebrities, it is possible that rich people would need more lawyers for drug possession, or drunk driving, etc. In this case as income became higher, we would see a higher quantity of criminal lawyers being demanded.
Those are the two things you need to remember when dealing with IEoD, the equation and what the sign means.