Income Elasticity of Demand

Definition:

A measure of the responsiveness of demand for a good in relation to a change in the level of money income amongst consumers.

Formula:

Example:

Price Elasticity of Demand

Definition:

A measure of the extent of changes in the market demand for a good in response to a change in price.

Factors Determining Price Elasticity of Demand

There are several factors which determine the price elasticity of demand.

Nature of the commodity:

The elasticity of demand for necessities of life is generally inelastic because due to increase in price, the demand for necessary commodities does not contract generally proportionately. However, for comforts and luxuries the elasticity of demand is elastic because even a smaller change in price brings bigger changes in quantity demanded. For example demand for wheat, sugar, rice, vegetables etc. is inelastic being necessities and for motor cars, air conditions demand is elastic being comforts and luxuries.

Number of substitutes:

If more substitutes are available for a product it would be more easy for consumers to shift from one product to another and consequently more elastic their demand would be. For example bathing soaps, tooth pastes, edible oils, soft drinks etc. have many substitutes that can be used for one another. On the other hand, electricity has no close substitute. Therefore, demand for electricity would be inelastic.

Goods having several uses:

Certain goods have different uses e.g. electricity is a necessity for certain uses, while for other uses it is a comfort or luxury. Use of electricity in the industry, for commercial purposes and for households also is a necessity and electricity used for decorative lighting is a luxury. Elasticity will be measured depending upon the use. More important the use is more inelastic the demand would be and less important the use is, more elastic the demand would be.

Durable Goods and perishable goods:

Demand elasticity is determined on the basis whether a good is durable or perishable. Generally demand for durable goods can be postponed. For example if there is a very high rise in prices, demand for motor cars, deep freezers, air conditioners can be postponed while perishable goods like fresh milk, vegetables and fruit etc. have inelastic demand as their use cannot be postponed.

Price Level:

Elasticity of demand for those goods which are either high priced or low priced is inelastic. An increase or decrease in price of high priced goods does not have greater impact on rich class. For example a change in price of “Mercedes” motor car will not yield significant effect on high rich class while lower middle class cannot purchase very high priced commodities already. However, if the commodity is low priced then it is already purchased in sufficient quantity so further fall in price does not cause an increase in demand. For example if the price of potatoes is Rs.10 per kg every consumer will be purchasing sufficient quantity. One rupee rise or fall in price would not cause any significant impact on demand.

Income Level:

For rich, elasticity of demand for different commodities is inelastic as an increase in price does not affect their consumption expenditure. For poor, elasticity of demand is elastic because even a smaller change in price brings greater change in demand. For example if price of petrol goes up by Rs. 50 per litre or falls by Rs. 50 per litre it will not cause significant change in the demand for rich class but would cause significant changes in the demand pattern of the less privileged and middle class people.

Consumer’s Loyalty:

Some goods and services are addictive in nature for example alcohol, drugs, cigarettes etc. Any rise in price will be unable to stop the use of these goods by addicted consumers. So their demand will be inelastic. Similarly some firms try to make their customers more and more brand loyal by excessive and persuasive advertisement. Their advertisement activities help them to develop habits of their brand. For example branded cellular phones and tablets.

Time:

Some goods are demanded in emergency for example lifesaving medicines. Their demand cannot be postponed. Therefore, demand elasticity is inelastic. However, goods like houses, motor cars have elastic demand because consumers can take enough time to adjust their demand.

Proportion of Income spent on the good:

Goods like “match box” are those goods on which consumers spend a very small proportion of income. Therefore, consumers remain indifferent to any change in price. But goods like LED TV, Houses, motor cars etc. are those goods on which a large proportion of consumers’ income is spent and therefore, these become elastic towards the price changes.

Sharia Law and Islamic Financing

Sharia Law:

Sharia law is the branch of statute that formalises the previously discussed principles of Islamic economics into law. For example, under Sharia Islamic law:

·        Making money from money – e.g. charging interest – is usury and therefore not permitted.

·        Wealth should only be generated through legitimate investment in assets and legitimate trade.

·        Investment in companies involved with gambling, tobacco

and alcohol is prohibited.

·        Short selling and non-asset backed derivatives are not permitted.

There are now a range of products freely available on the global financial markets that comply with Sharia Islamic law. These include bank current accounts, mortgages and even personal loans.

Islamic Financing:

The Islamic financial model works on the basis of sharing risk. The bank and customer agree terms on how to share risk of an investment then divide profits between them. Whilst customers risk losing their money if the investment is unsuccessful, the bank will not charge a handling fee unless it secures the customer a profit.

Whilst the range of available financial product types continues to grow, some of

the key categories of Islamic finance are:

·        Mudaraba: This is where a financial expert offers specialist investment in which the customer and bank share profits.

·        Musharaka: This is an investment partnership with profit sharing terms agreed in advance and losses limited to the initial capital invested.

·        Murabaha: This is a form of credit that enables customers following Islamic principles to make a purchase without the need to take out an interest bearing loan. The substance of the transaction is that the bank buys an item then sells it to the customer on a deferred basis.

·        Ijara: This is a leasing agreement whereby the bank buys an item for a customer then leases it back to them over an agreed time period. The bank makes a fair profit by charging rent on the property.

·        Ijara-wa-Iqtina: Similar to Ijara but the customer is able to buy the item at the end of the contract.

Circular Flow of Income

One of the most important models used by economists to describe an economy

is the circular flow of income. Circular flow of income diagrams are used to

illustrate the different sectors and markets with in an economy.

Money flows between households and firms through the purchase of goods and

services. There are two sides to every transaction. The business sector uses

labour provided by the household sector to produce goods and services and pays

for this labour. These are then sold to other firms within the business sector and

to households.

Concepts Of National Income

                       CONCEPTS OF NATIONAL INCOME

Ø Gross Domestic Product:

Total value or money value of all the final goods and services produced by nation in one financial year with in the boundaries in a country is called gross domestic product.

GDP = Consumption + Investment + Govt. Spending + (Export – Import)

Ø  Gross National Product:

Total value or money value of all the final goods and services produced by nation in one financial year is called gross national product. If we add net factor income from abroad or net foreign remittances into GDP, we will get GNP.

GNP = GDP + Net Factor From Abroad

Ø  Net National Product:

Total value or money value of net national output value after compensating depreciation or capital consumption allowance is called net national product. It is also called national income at market price.

NNP = GNP –­ Capital Consumption

Ø  National Income At Factor Cost:

Net income received by all the factors of production in an economy after factor cost adjustment is called national income or national income at factor cost.

NI = NNP – Indirect Taxes + Subsidies

Ø  Personal Income:

Total income received by all the legal residents of an economy in one financial year is called personal income.

PI = NI – Retained Earnings + Transfer Payments

Ø  Disposable Income:

Income which remains for onward economic activities (savings or consumption) after the adjustment of direct taxes is called disposable income or disposable personal income.

DPI = PI – Direct Taxes (personal taxes)

What is National Income OR Definition of National Income

NATIONAL INCOME

Definition:

Total Income earn by all the legal residents of an economy in one financial year is called national income.

OR

Total income earn by all the factors of production of an economy in one financial year is called national income.