The income elasticity of demand (YED) measures the responsiveness of a change in the quantity demanded to a change in the level of consumer income. It is calculated using the following formula;

The value will indicate some characteristics of the good. For instance;

• Between zero and one (inelastic) - quantity demanded of good A changes by a smaller percentage than the change in consumer income.
• Between one and infinity (elastic) - quantity demanded of good A changes by a larger percentage than the change in consumer income.

The sign indicates the relationship between two goods. For instance, normal / luxury goods have a positive sign and inferior have a negative sign.

Many economists suggest that if the value is greater than 1, then the goods are likely to be luxury items (very sensitive to changes in level of household income, while is the value is less than 1 then they tend to be normal goods.

The following is an example of how to calculate the YED;

Original income = £800
Original quantity of good B = 20 units
New income = £900
New quantity of good B = 25 units

In other words, a £100 increase in income will result in a 5 unit increase in the quantity demanded. The income elasticity of demand is

= 0.05 * 40 = 2.0

Therefore, the income elasticity of demand is 2.0, which is termed as relatively elastic. The sign and value imply that the good is a luxury item.