Income elasticity shows fluctuations in demand for goods or services as precipitated by changes in the purchasing power of consumers. Consumers adjust their spending habits along with changes in their disposable income. The higher the disposable income, the greater the ability of consumers to afford expensive items, and vice versa. This may either enhance or diminish your business prospects depending on your industry of specialization. As such, your business decisions should be sensitive to the impact of income elasticity on your particular industry.

Coefficients of Elasticity

A coefficient is a metric that expresses the income elasticity of demand for a particular product or service. To calculate your coefficient of income elasticity, divide the percentage change in the quantity of demand for a product by the percentage change in income. This formula may yield either a positive or negative elasticity.

Positive Elasticity

Positive income elasticity is a situation where the demand for a particular product increases with growth in income levels and decreases with decline in income. This type of elasticity is associated with superior products. McConnell Brue Flynn, author of the online edition of Economics 19e, identifies restaurant meals, automobiles and housing as some examples of superior goods. Positive elasticity prevails during periods of economic prosperity because consumers earn more money from their employment or business activities.

Negative Elasticity

Negative income elasticity prevails when the demand for certain products, usually referred to as inferior goods, decline as a result of rising income. The demand for these products increases with dipping income levels. These goods are essential, and consumers must have them by all means, regardless of a fall in income levels. As such, consumer preferences for inferior goods rises during periods of economic decline. For example, consumers may opt to use public transport instead of driving when oil prices rise as a result of inflation. This means that higher demand for bus tickets would have been occasioned by falling income levels among consumers.

Economic Growth

The dynamics of income elasticity reflect the trends of economic growth. Income levels increase with economic growth and decrease with economic decline. It is imperative to adjust your small-business activities according to changes in economic conditions. For example, when incomes fall as a result of economic downturn, demand for non-essential items such as jewelry and luxury vacations drops. You have to be cautious and produce or stock fewer non-essential items during such periods of economic decline.