Importance of income Elasticity of demand

Importance of income Elasticity of demand
Importance of income Elasticity of demand

Importance of income elasticity of demand

As discussed below, the definition of the income elasticity of demand is of great theoretical and practical importance:

  1. Knowledge of the essence of goods:

Income elasticity is a term that helps to differentiate between important and non-essential goods. High-income elasticity commodities are luxuries. As a person becomes affluent, he spends higher proportions of his income on goods such as scooters, jewelry, air conditioners, television sets, etc. When revenue increases, the proportion of revenue spent on matches, soaps, newspapers, salt, shoes, etc. falls. We may usually assume that in the case of non-essential goods, the income elasticity of demand is greater than 1 and less than 1 for essential goods. But a straight cut distinction between the two is difficult to make, because a good that is a necessity at a specific level of income may become luxury at another level.

  1. Helpful in Business Research:

Among the analytical methods used for business research, the definition of income elasticity is of great importance. The definition of income sensitivity, which is closely linked to income elasticity, has been included in recent times. The difference between the two concepts is that while the physical units of the purchased commodity concern income elasticity, income sensitivity tells us about changes in money-expenditure. Income sensitivity has a coefficient that calculates the percentage increase in Rupee expenditure associated with a change in disposable income of one percent over the same span. Estimates of income sensitivity are of great value in market forecasting. Telephone service, automobiles, air transport, foreign travel, viz., were found to have high-income sensitivities (coefficient equal to 1.5 or more), while shoes, clothing, local bus, transport, and dental care have low-income sensitivity (coefficient less than 0.5).

  1. Importance of production planning:

As the standard of living increases in less developed countries such as India, demand for certain goods is projected to grow much faster than demand for others. Demand for food and clothing appears to be strong in the earlier stages. Generally speaking, as income grows, there is a lack of food and clothes, which leads to inflation when not fulfilled. Similarly, demand for comforts and luxuries such as Scooters, Mopades, Air Conditioners, Cell Phones, Readymade Apparel, Superior Footwears, and Medical Care have high-income elasticity of demand in urban areas, which act to establish an acute shortage of these products and services. Rural areas tend to decrease the marketable surplus of food products, thus placing pressure on producers’ demand. The distinct income elasticity of demand and supply generates an inter-sectoral balance problem. If planners are aware of the revenue elasticity of demand for at least general-purpose goods and services, steps may be taken to balance demand and supply by the implementation of special controls or the diversion of resource factors. The propensity of prices to increase may thus be contained.

Importances of Demand cross elasticity

The meaning of the cross elasticity of demand follows:

  1. Commodity classification:

The principle of cross elasticity of demand can be used to classify goods into three groups viz.-(i) Substitutes-The goods for which cross elasticity is positive will replace the two goods with each other,

(ii) Complementary-If cross elasticity is negative, the goods will complement each other

(iii) Independent goods

  1.  Helps to define industry:

To define an industry, the notion of cross elasticity helps. High cross elasticity of commodities that are close replacements and low cross elasticity of commodities that are bad replacements. This disparity helps identify an industry. Companies that manufacture close replacements with a high degree of cross-elasticity can be regarded as one field. In comparison to other products, a good with a low cross-elasticity may be called a monopoly commodity and its production business becomes an industry by itself. But no fixed rules for deciding the limits of the industry are laid down by high and low cross elasticity.


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