Consumer income (Y) is a key determinant of consumer demand (Qd). The relationship between income and demand can be both direct and inverse.
In the case of normal goods, income and demand are directly related, meaning that an increase in income will cause demand to rise and a decrease in income causes demand to fall. For example, luxuries like cars and computers are normal goods for most people.
In the case of inferior goods income and demand are inversely related, which means that an increase in income leads to a decrease in demand and a decrease in income leads to an increase in demand. For example, necessities like bread are often inferior goods.
It should be noted that ‘normal’ and ‘inferior’ are purely relative concepts. Any good or service could be an inferior one under certain circumstances. Even luxury goods can become inferior over time. Video players were once luxuries, but as incomes have risen consumers have switched to DVDs.
Engel Curves, named after 19th Century German statistician Ernst Engel, illustrate the relationship between consumer demand and household income.
Engel curves for normal goods slope upwards – the flatter the slope the more luxurious the good, and the greater the income elasticity. In contrast, Engel curves for inferior goods have a negative slope.
Demand for the three goods, shown here, all respond very differently to the same change in income, Y to Y1. Demand for the normal good increases from Q to Q1, demand for the luxury good rises much more, to Q2, and demand for the inferior good falls from Q to Q3.