Association of Chartered Certified Accountants (ACCA) Certification Practice Test

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What is the formula for income elasticity of demand (IED)?

IED = % change in quantity demanded ÷ % change in price
IED = % change in quantity demanded ÷ % change in household income
IED = % change in price ÷ % change in quantity demanded
IED = % change in household income ÷ % change in quantity demanded

The correct answer is: IED = % change in quantity demanded ÷ % change in household income

The income elasticity of demand (IED) measures how the quantity demanded of a good responds to changes in consumer income. The formula expressing this relationship is the percentage change in quantity demanded divided by the percentage change in household income. This means that when income levels rise or fall, the way consumers adjust their purchasing behavior can be quantified using this formula. If a good has an income elasticity greater than one, it is considered a luxury good because demand increases proportionally more than the increase in income. Conversely, goods with an income elasticity between zero and one are considered necessities, as their demand increases but at a lower rate than income. It’s essential to note that the other options you provided revolve around different concepts. They either deal with price elasticity or incorrectly frame the relationship between demand and income. This makes understanding that the IED specifically focuses on income change crucial for correctly applying the concept in economic analysis.