We all know about the growth story of an economy. In order to progress from a developing economy to a developed economy, the country has to shift it’s labour force from the primary sector to the tertiary sector. The efforts to do the same are being made by all the BRICS nations, even though the Planning Commission of India has been blamed for not having planned the growth story right by not having put emphasis on industrialization first and thereby moving towards the development and expansion of the tertiary sector. But why is it proposed that only those economies which shift their production allocation from the primary to the tertiary sector are the ones which are on the right path towards development? The answer lies in the simple principle of economics: income elasticity of demand.
Income elasticity of demand measures the responsiveness of demand when there is a change in the income of consumers. In numerical terms, it is measured by dividing the percentage change in quantity demanded by the percentage change in income. For normal goods, the income elasticity of demand is positive since income and demand are directly correlated, whereas for inferior goods, the income elasticity of demand is negative since income and demand are inversely correlated.
So what would the income elasticity of demand be for primary goods such as wheat and rice? In simpler words, would you buy more wheat and rice just because you get a raise at work? Initially, you probably might buy some more quantity of wheat and rice. However after a point of time, you will stop purchasing the extra amounts of wheat and rice even though your income may rise because irrespective of your income there is only a certain amount that you can consume. In case of other primary goods such as fruits and vegetables, the consumption also stops because of the goods being perishable. Similarly, a decrease in income would not affect your consumption drastically since primary goods are usually necessities that are essential for survival. Therefore, since a large increase in percentage of income has a lower percentage change in the quantity demanded, the income elasticity of primary goods is inelastic.
This means that the scope of growth in primary sector is lower than that in secondary or tertiary sector since the consumption cannot be drastically increased for primary goods. Thus the economies that highly depend on primary goods grow less that the economies which focus on their manufacturing and tertiary sectors, since the goods of the secondary and tertiary sector are relatively more income elastic. That is, the consumption of these industrial goods or services is impacted by the income of consumers and an increase in income has a greater responsiveness in terms of quantity demanded and thereby helps to increase profits for manufacturers since there is a demand for these goods that the manufacturers sell. This provides a larger scope for the economy to grow. Thus because of this concept of income elasticity of demand, the developing countries across the world are focusing on the growth of their respective manufacturing sectors.
