His income has risen by $1,000 from an original income of $10,000, which is a change of +10%. This can be calculated by the equation
(+1,000/10 000) x 100% = +10%.
The quantity demanded of branded clothes has increased by $200 from an original demand of $1,000, which is a change of +20%. This can be calculated by the equation
(200/1,000) x 100% = +20%.
When the two values are substituted into the equation for income elasticity of demand, we end up with (+20%/+10%) which provides the value of +2.
The number and sign obtained from the income elasticity of demand equation is very important as the sign (positive or negative) determines if the product studied is a normal good, necessity or inferior good.
For normal goods, the value of income elasticity of demand is positive as the demand for the product increases as income increases. If the percentage increase in quantity demanded is less than the percentage increase in income, then the income elasticity of demand value would be between zero and one and the demand for the normal good will be determined as being income-inelastic. If the percentage increase in quantity demanded is greater than the percentage increase in income, then the income elasticity of demand value will be greater than one and the demand for the product will be determined as being income-elastic.
Necessity goods are usually products that have a low income elasticity and the demand for them will not vary by a significant amount following a rise in income. For example, the demand for rice or pasta will not increase significantly as income rises because many people will already have enough rice or pasta and therefore will not choose to increase consumption.
For inferior goods, the value of income elasticity of demand will be negative as the demand for the product will decrease as the income increases as people will start to purchase larger quantities of superior goods that they are now able to afford. For example, the demand for inexpensive, budget-price clothing will fall as income rises as people will now be able to purchase branded clothing as a result of an increase in income.
In addition to normal, necessity, and inferior goods, there are also a fourth category of products called superior goods. Superior goods are products that often have a high income elasticity. The demand for them will vary significantly following a rise in income as people have more income to satisfy their needs, they will begin to use their money to purchase products that are wants. These wants are usually non-essential with common examples being computers, phones, electronics and vacations in foreign countries. These products or services are determined as being income-elastic.