Lecture 11: How do businesses make use of estimates of income elasticity of demand?
Knowledge of income elasticity of demand for different products helps firms predict the effect of
a business cycle on sales. All countries experience a business cycle where actual GDP moves up
and down in a regular pattern causing booms and slowdowns or perhaps a recession. The
business cycle means incomes rise and fall.
Luxury products with high income elasticity see greater sales volatility over the business cycle
than necessities where demand from consumers is less sensitive to changes in the economic
The UK economy has enjoyed a period of economic growth over the last twelve years. So
average real incomes have increased, but because of differences in income elasticity of demand,
consumer demand for products will have varied greatly over this period.
Income elasticity and the pattern of consumer demand: Over time we expect to see our real
incomes rise. And as we become better off, we can afford to increase our spending on different
goods and services. Clearly what is happening to the relative prices of these products will play a
key role in shaping our consumption decisions. But the income elasticity of demand will also
affect the pattern of demand over time. For normal luxury goods, whose income elasticity of
demand exceeds +1, as incomes rise, the proportion of a consumer’s income spent on that
product will go up. For normal necessities (income elasticity of demand is positive but less than
1) and for inferior goods (where the income elasticity of demand is negative) – then as incom