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An income expansion path is a graph illustrating the impact of varying income levels on consumption. The lines on the graph represent how prices affect the consumer and the items they purchase. The graph also shows how income levels affect the purchase of these items. Thus, the income expansion path shows how income affects the demand for goods.
Unit Income Elasticity
When the consumer has unit income elasticity, the income expansion path is a straight line. This type of consumer will consume the same amount of commodities, including both luxury items and necessities, at each level of income. Retailers use this data to determine purchasing patterns for different types of customers. Although purchasing patterns are not an exact science, studying income levels helps retailers gauge possible future sales.
Consumers who receive an increase in income can spend more on both luxury items and necessities. However, many customers gravitate towards luxury goods as income increases, resulting in a bending income expansion line on the graph. In economic terms, a luxury good has a high income elasticity demand. This means a luxury item is a good whose consumption increases as the rate of income increases. A necessity, on the other hand, represents something the consumer cannot live without. Therefore, consumers always purchase necessities such as food, regardless of the price.
Inferior goods are those the consumer generally won't purchase as income increases. The average consumer has less demand for inferior goods, which is represented by a backward bend in the income expension path. Therefore, inferior goods have a negative income elasticity for demand. Normal goods, on the other hand, represent the goods that show an increased demand as your income level increases.
Consumer Demand Behavior
Retailers and economists alike try to predict consumers' future behavior, and the market's demand function, with another income expansion path called the price offer curve. Because you cannot mathematically dictate behavior, the numbers used for this model come from past performance. Any future analysis, therefore, represents an educated guess that you should only use in conjunction with other information.The price offer curve describes the demand behavior of the consumer.
- David Fried: The Consumer: Choice and Indifference Curves
- "Principles of Macroeconomics"; N. Gregory Mankiw; 2008
Brian Bass has written about accountancy-related topics and accounting trends for "Account Today." He works as a senior auditor specializing in manufacturing and financial services companies for one of the Big 5 accounting firms. Bass hold a master's degree in accounting from the University of Utah.