Income elasticity of demand versus consumption: Implications for energy policy analysis

Highlights: • Contrast between income elasticity of demand and consumption is highlighted. • The income elasticity of consumption depends on the characteristics of the supply function. • Income elasticity of consumption potentially smaller than the income elasticity of demand. • The difference depending on the shapes of both the demand and supply functions. • Partial and general equilibrium extensions discussed in the paper. The income elasticity of consumption depends not only on the demand function but also on the characteristics of the supply function. If the supply of the underlying good (e.g., gasoline, natural gas, or housing) is not completely elastic, the income elasticity of equilibrium consumption will be less than the income elasticity of demand, with the difference depending on the shapes of both the demand and supply functions. We derive analytical expressions for the wedge between the two elasticities and discuss the implications for the energy policy analysis.