In economic theory, a change in income typically results in a change in demand for goods and services. The actual change in demand that occurs will depend on the specific good or service. Additionally, different individuals will respond differently to changes in their income. Some individuals will tend to save more of their increased income than others, as opposed to spending the increase on goods and services.
Marginal Propensity to Consume
The marginal propensity to consume is a measurement of a consumer's consumption and savings choices given a particular increase in income. Some individuals will tend to spend a larger proportion of an increase in income than others. For example, if both John and Beth receive a $500-per-week raise, John may choose to spend $400 of that raise on clothes and fine dining and save the other $100, while Beth may choose to save $300 of her raise and spend the rest.
Income Elasticity of Demand
The income elasticity of demand is a measure of the responsiveness of demand for a good to changes in income. Some goods are very responsive to increases in demand, such as cars, meaning that an individual who experiences an increase in income will be likely to consider purchasing a car. Other goods are not as affected.
Superior or Luxury Goods
Superior goods are goods that a consumer is more likely to demand and consume given an increase in income. Such goods include designer clothing, restaurant meals and electronics. Consumption of these goods will increase depending on both the marginal propensity to consumer of the consumer and the income elasticity of demand of the good or service.
Inferior goods are goods for which consumption decreases with an increase in demand. Consumers generally consume these goods only because they cannot afford better goods. A classic example of an inferior good is public transportation. As an individual's income increases, she is less likely to use public transportation and more likely to take taxis or use her own vehicle.
Necessities are goods that do not tend to change significantly with increases or decreases in income. Public utilities are examples of necessity goods. Individuals tend to consume roughly the same amount of power and water regardless of changes in their income. Food is another necessity.
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