Income elasticity of demand

Also called: YED · Topic: Consumer Behaviour, Demand and Elasticity · NCERT: Beyond NCERT

Meaning

Income elasticity of demand (eY or YED) measures how much the quantity demanded of a good changes when a buyer's income changes, while the price of the good stays the same.

• Formula: eY = % change in quantity demanded ÷ % change in income = (ΔQ/Q) ÷ (ΔY/Y). Here Q is quantity and Y is income.

It tells us which goods people buy more of as they get richer. This is why food takes a smaller part of the family budget as incomes rise (Engel's law). It is also why India's CPI weights have to be revised from time to time.

Explanation

How it works: the sign and the size

• The sign tells you the type of good.
• eY positive → normal good. Income rises, so demand rises.

• eY negative → inferior good. Income rises, so demand falls, because people switch to better items.

• The size tells you what kind of normal good it is.

eY	Type of good	When income rises	Examples
< 0	Inferior	Demand falls	Coarse grains for richer households, cheap cloth
0 to 1	Necessity (normal)	Demand rises, but by a smaller % than income	Foodgrains, salt, basic clothing
> 1	Luxury (normal)	Demand rises by a bigger % than income	Jewellery, foreign travel, cars

• Necessities and luxuries are both normal goods. "Normal" only means eY is positive.
• Price is held constant. eY isolates the effect of income alone.

Worked examples

• Necessity:
• A family's income rises from ₹20,000 to ₹22,000 a month, which is +10%.
• Its rice purchase rises from 25 kg to 26 kg, which is +4%.

• eY = 4 ÷ 10 = 0.4. This is between 0 and 1, so rice is a necessity for this family.

• Luxury: income rises by 10% and spending on restaurant meals rises by 25%. eY = 25 ÷ 10 = 2.5, so restaurant meals are a luxury.

• Inferior: income rises by 10% and purchases of coarse cloth fall by 5%. eY = −5 ÷ 10 = −0.5, so coarse cloth is an inferior good.

What decides the value of eY

• How essential the good is:
• Necessities such as foodgrains have eY between 0 and 1. People already buy most of what they need, so extra income goes mostly to other things.

• These goods are also usually price inelastic: demand barely changes when the price changes, because people cannot easily go without them.

• Whether the good can be put off:

• Luxuries have eY above 1. Their demand grows fast with income.

• They are usually price elastic: demand changes a lot when the price changes, because people can delay or skip the purchase.

• Who the buyer is:

• The same good can be of a different type for different households.

• Coarse grains are inferior for richer households. For very poor households whose incomes are rising, they can be normal.

• Link to NCERT Class 12: Class 12 sorts goods into normal and inferior. It also says necessities are price inelastic and luxuries are price elastic. eY puts a number on these ideas.

Engel's law: eY applied to food

• Engel's law (Ernst Engel, 1857): as household income rises, the share of income spent on food falls, but the amount spent on food in rupees still rises.

• Why: food as a whole is a necessity (eY < 1), so food spending grows more slowly than income.

• Worked example:

• Income is ₹10,000 and food spending is ₹5,000, so the food share is 50%.
• Income doubles to ₹20,000 and food spending rises to ₹7,000, so the food share falls to 35%.

• Food spending rose 40% while income rose 100%, so eY for food = 40 ÷ 100 = 0.4.

• Engel curve (a graph of spending on a good against income):

• For a necessity, it rises but flattens out.
• For a luxury, it rises more and more steeply.

In India

• Who measures it: MoSPI (Ministry of Statistics and Programme Implementation) runs the Household Consumption Expenditure Survey (HCES). The survey measures MPCE (monthly per capita consumption expenditure, the average amount a household spends per person each month).
• Share of food in MPCE, which shows Engel's law in India:

Year	Rural food share	Urban food share
2011-12	~52.9%	~42.6%
2022-23	~46.4%	~39.2%
2023-24	47.04%	39.68%

• The 2023-24 food share was 47.04% in rural areas and 39.68% in urban areas [1][2].
• Across groups: average MPCE in 2023-24 was ₹4,122 in rural areas and ₹6,996 in urban areas [1]. Urban households are richer and spend a smaller share on food.
• Over time: rural MPCE rose from ₹1,430 (2011-12) to ₹3,773 (2022-23) and ₹4,122 (2023-24) [1][6]. Over the same years, food shares fell sharply.
• The 2023-24 blip: the rural food share rose slightly from 2022-23 to 2023-24. One year's rise does not disprove the law. Engel's law describes long-run trends and differences between income groups.
• Within the food basket:
• In 2023-24, beverages, refreshments and processed food had the largest spending share within food, in both rural and urban areas [1].

• Cereal spending is shrinking while protein items (milk, eggs, fish, meat) are rising. Cereals have low eY. Protein and convenience foods have higher eY.

• Effect on the CPI (Consumer Price Index, which tracks prices of a fixed basket of goods households buy, with each item weighted by its share in spending):

• In the 2012-base CPI, food and beverages had a weight of 45.86%.
• In the new CPI series (base 2024 = 100), the weight is 36.75%, based on HCES 2023-24 [3][4].
• Part of this drop comes from the new COICOP 2018 classification (the UN's system for grouping consumer spending). Under the old classification, the food and beverages share would have been 40.10% [4].

• Food and beverages are still the largest component of the CPI basket [4].

• For the farm economy:

• Demand for cereals grows slowly as incomes rise.
• So farm incomes depend on moving towards high-eY products such as dairy, fruit and protein.
• Food processing under the PM Kisan SAMPADA Yojana supports this shift [5].

Don't confuse with

• Price elasticity of demand: this measures the response of demand to a change in the good's own price. eY measures the response to a change in income, with price held constant.
• Cross elasticity of demand (eXY): this measures the response of demand for X to a change in the price of another good Y. A positive eXY means substitutes (tea and coffee). A negative eXY means complements (tea and sugar). The sign of eY tells you normal vs inferior, not substitute vs complement.
• Necessity vs inferior good: a necessity has positive eY below 1, so demand still rises with income, just slowly. An inferior good has negative eY, so demand actually falls. Both can be cheap goods, but only the second is "inferior".
• Engel's law (share) vs absolute spending: Engel's law says the share of food in the budget falls. The rupee amount spent on food still rises. This is a common MCQ trap.

Prelims Hooks

• eY = % change in quantity demanded ÷ % change in income, with price held constant. eY < 0 → inferior; 0 < eY < 1 → necessity; eY > 1 → luxury.
• Necessities and luxuries are both normal goods. Only goods with negative eY are inferior.
• The same good can be inferior for one household and normal for another. Coarse grains are inferior for richer households but can be normal for very poor households.
• Engel's law (1857): as income rises, the food share falls because food has eY < 1. HCES 2023-24 food share: rural 47.04%, urban 39.68% [1][2].
• The largest item within food spending in 2023-24 was beverages, refreshments and processed food, not cereals [1].
• CPI food and beverages weight: 45.86% (base 2012) → 36.75% (base 2024, weights from HCES 2023-24, COICOP 2018) [3][4].

Mains Points

• Engel's law and inflation targeting:
• Food has low eY, so its share in spending is falling. HCES 2023-24 shows 47.04% in rural areas and 39.68% in urban areas [1].
• This led to the CPI being rebased, with the food weight cut from 45.86% to 36.75% [3][4].

• Vegetable-price shocks now move headline inflation less than before. This matters for the RBI's inflation targeting and for the debate on targeting headline or core inflation.

• Farm incomes and crop diversification:

• Cereals have low eY, so their demand grows slowly as the country gets richer.
• Farmers who depend only on cereals see their income lag behind.

• Policy should shift production towards high-eY items (dairy, fruit, protein) and build food processing, for example under the PM Kisan SAMPADA Yojana [5].

• Changing diets and public health:

• Rising incomes are moving food spending towards processed food and beverages [1].
• This creates growth chances for the food-processing industry.
• It also raises nutrition worries, such as diets high in fat, sugar and salt. Food labelling and nudges (small changes in how choices are presented, as in Economic Survey 2018-19, chapter 2) can help here.

Related concepts

• Cross elasticity of demand
• Necessity good
• Luxury good
• Engel's law

Read more

• Income and cross elasticity, Engel's law and the policy uses of elasticity