Income elasticity of demand | APⓇ Microeconomics | Khan Academy

In previous videos, we have talked about the idea of price elasticity. It might have been price elasticity of demand or price elasticity of supply, but in both situations, we were talking about our percent change in quantity over our percent change in price.

If we were talking about price elasticity of demand, it would be the percent change in quantity demanded over the percent change in price. If we're talking about price elasticity of supply, it would be our percent change in quantity supplied over a percent change in price. As we talked about in many videos, this is a way of measuring how sensitive quantity demanded or supplied is to a change in price.

What we're going to see in this video is that this is not the only type of elasticity that economists will look at. There are many types of elasticity where they want to see how sensitive one thing is to another. For example, you could look at the percent change in labor supply. You could say quantity of labor, that would be our labor supply, divided by our percent change in wages.

I'll just write it out: wages. You could view that as our percent change in the price of labor. So you might say, "Hey, this is just a price elasticity of supply being particular to the labor market." But you can even see things, and we'll have a whole video about this probably in my next video that I will make, where you could have the percent change in, let's say, quantity demanded of one good divided by — so let me call it good one — divided by the percent change in price of not that good. Then we would have price elasticity, but of good two.

This is actually thinking about how good one is a substitute for the other. We'll go into a lot more depth there. But the focus of this video, as you can imagine because it was already written down in a clean font right over here, is income elasticity. Here we're going to think about the income elasticity of demand, and you could imagine what that would be.

This is going to be our percent change in quantity demanded divided by, instead of thinking about the percent change in price of that good or the service, we're going to think about the percent change in income of the people who might be in the market for that good. So normally, you would expect that when our percent change in income goes up, that the same thing would happen to our percent change in quantity demanded.

For example, let's say we're talking about the market for vacations. Well, as my income goes up, as most people's incomes go up, they might be able to afford larger or better vacations, and that would be a normal good. So this is a situation of a normal good — normal good just as what you would expect.

But you could actually have the other way around. You could imagine a situation where, even though you have an increase in your percent change in income that does not lead to an increase in your percent change in quantity demanded; in fact, it could lead to a decrease in the percent change in quantity demanded. Or, another way of thinking about it, your quantity demanded could actually go down.

So you would have a negative percent change right over here. Now, can you imagine any situations like that? Well, imagine if we're talking about the market for car mechanic services. As people have more income, they might be able to afford better cars that are more reliable, that break down less, and then they would have to go to the car mechanic less.

And so that situation where our demand would actually go down when our income goes up, or our percent change will become negative when we have a positive percent change in income, that would be known as an inferior good — inferior good.

So there's two big things to take away: one, you don't just have to think about price elasticity of supply or demand; there are other types of elasticities. But just to hit the point home on income elasticity, let's look at a few examples.

So we're told, suppose that when people's income increases by twenty percent, they buy ten percent less fast food. In this situation, what type of good would fast food be? Pause this video and think about it.

Well, their income is increasing, but their demand is decreasing. So that's the situation we just talked about; this is an inferior good — inferior good. And for kicks, what is the income elasticity of demand right over here? Calculate that.

So just remember, our income elasticity of demand is just going to be our percent change in quantity demanded divided by our percent change — instead of price, we're going to say in income. I'll just write percent change of income, which is going to be what? Well, we know our percent change in income; it went up by 20 percent in this example, and what happened to our quantity demanded? Well, it went down by 10, so negative 10.

And so here you have an income elasticity of demand of negative one-half or negative 0.5. Let's do another example: suppose we knew that when people's income increased by five percent in a country, the demand for health care increased by ten percent. What kind of good do people consider health care — normal or inferior?

So first, calculate the income elasticity of demand for this example and then answer these questions. All right, so first we are our income elasticity of demand. Let's see; when our income increases by five percent, so we have a five percent increase in income, our demand for healthcare increases by 10 percent.

So we get a positive income elasticity of demand, and so in general, if this thing is positive, you're dealing with a normal good. As income goes up, then you similarly see quantity demanded going up. So this is a normal good.