What is income elasticity of demand?

Income elasticity of demand measures how sensitive purchases of a good are to changes in income. It is calculated as the percentage change in quantity demanded divided by the percentage change in income. The sign and size of the result tell a business or a planner whether demand will grow, hold or shrink as people get richer or poorer.

How it works

A positive value means demand rises with income, which is true of normal goods. A value above 1 means demand rises faster than income, which is typical of luxury goods. A value between 0 and 1 means demand grows more slowly than income, as with necessities. A negative value means demand falls as income rises, which defines inferior goods.

Because the measure depends on the income range and on what alternatives exist, it is best read as local: a good can be a necessity for one income group and a luxury for another.

Example

Say average household income rises by 10%. Sales of restaurant meals rise by 15%, so the elasticity is 15 / 10 = 1.5, and restaurant meals behave like a luxury. Sales of bread rise by 2%, so the value is 0.2, a necessity. Sales of instant noodles fall by 5%, so the value is -0.5, an inferior good. A recession that cuts income by 10% would reverse each of these movements. Illustrative numbers only.

In a game economy, a player's income is their earning rate, and designers check whether richer players buy proportionally more premium items or switch from cheap items to better ones.

How to model it in Machinations

Use a Register for income and a Register for demand, and a State connection from income to the demand rate with a slope equal to the elasticity. Put the elasticity and the income growth as Levers. Play and chart demand against income to see which goods grow, stall or shrink.