How does a change in income affect luxury goods compared to basic goods?

In one line

The rule

When people's income increases, the demand for luxury goods rises much more than the demand for basic (necessity) goods.

• For luxury goods: Income Elasticity of Demand > 1 (demand rises faster than income)
• For basic goods: Income Elasticity of Demand < 1 (demand rises slower than income)

Where:

• Income Elasticity of Demand means how much demand changes when income changes.

Let's understand it simply

Imagine you get extra pocket money this month. What will you do? You may buy more chocolates (a treat), or maybe a new cricket bat. But will you eat double the amount of rice or chapati? No! You only eat as much as you need.

Basic goods are things you must have—like rice, dal, salt, soap. You buy them even if you have less money, and you don’t buy much more even if you get richer. Luxury goods are things you want but don’t need—like a fancy watch, branded shoes, or a big TV. When you have more money, you start buying these things.

How it works

1. Income rises: You or your family get more money (maybe a salary hike or a bumper crop).
2. Basic goods: You buy a little more, or maybe better quality, but not much more (you can’t eat 10 plates of food!).
3. Luxury goods: You start buying things you couldn’t afford before—designer clothes, a car, eating out at restaurants.
4. Income falls: If money drops, you cut back on luxuries first, but still try to buy the basics.
5. Result: Demand for luxury goods changes a lot with income, but demand for basics changes only a little.

The story behind it

Economists noticed this pattern in the 19th century. Ernst Engel, a German statistician, studied how families spent their money. He found that as income rose, people spent a smaller share on food (a basic good) and more on other things (luxuries). This became known as Engel’s Law.

Where you see it in real life

• Buying a car: A family in a village may buy a cycle first (basic), but when income rises, they buy a scooter or car (luxury).
• Festive shopping: During Diwali, people with extra income buy gold jewellery or new clothes (luxury), but not double the atta or rice.
• Mobile phones: Most people have a basic phone. With more income, they upgrade to a smartphone with extra features.
• Eating out: When income rises, families go to restaurants more often (luxury), but still cook dal-chawal at home (basic).
• Travel: With more money, people take holidays to Goa or abroad (luxury), but don’t spend more on daily bus fare (basic).
• Schooling: Basic education is a must, but with more income, parents may send children to private schools with extra facilities (luxury).

Why it matters

• Business planning: Companies decide what to sell based on income trends—luxury brands target rich areas, basic goods are sold everywhere.
• Government policy: Helps decide what to tax or subsidize—luxuries may have higher taxes, basics may get subsidies.
• Economic growth: As a country gets richer, demand for luxury goods rises, creating new jobs and industries.
• Exams and careers: Questions on income and demand come in board exams and entrance tests like UPSC, CA, and MBA.

Worked example

Let’s say a family’s income rises by 20%.

• They spend 5% more on rice (basic good).
• They spend 40% more on eating at restaurants (luxury good).

Given: Income rises by 20%
Basic good (rice): Demand rises by 5%
Luxury good (restaurant meals): Demand rises by 40%
Step 1: Calculate income elasticity for rice = 5% / 20% = 0.25 (<1)
Step 2: Calculate income elasticity for restaurant meals = 40% / 20% = 2 (>1)
Step 3: Conclusion: Demand for luxury goods is much more sensitive to income changes.

Common mistakes

• Thinking all goods are affected the same by income: They’re not. Luxuries change a lot, basics only a little.
• Mixing up luxury and basic goods: Remember, basics are must-haves (food, soap), luxuries are nice-to-haves (gadgets, branded clothes).
• Forgetting about inferior goods: Some goods (like cheap noodles) are bought less when income rises.
• Assuming everyone’s luxuries are the same: What’s a luxury for one person may be a basic for another (cycle vs. car).

Remember it

When income goes up, luxuries go up a lot, basics only a bit.