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Income elasticity of demand measures how much people change their buying habits when their income changes.

It is quantified as the percentage change in the quantity demanded of a good divided by the percentage change in income.

It helps to classify goods into different groups. First, there are inferior goods. These have a negative income elasticity.

An example is cheap instant noodles. As people earn more, they often upgrade to higher-quality food.

Then there are normal goods. They have an income elasticity value greater than zero but less than one. With increased earnings, individuals often elevate their lifestyle, such as transitioning from a basic phone to a more advanced smartphone.

Lastly, there are luxury goods. These have an income elasticity value greater than one.

An example is an individual upgrading from an ordinary car to a fancy sports car when they have a lot of money to spend.

This concept helps businesses predict sales under different economic conditions.

Additionally, it assists governments in understanding the effect of income tax changes on consumer spending patterns in the economy.