Calculating Income Elasticity:

When the income of a household increases by 10% and the demand for cars rises by 20%, we can calculate the income elasticity of demand using the following formula:

Income Elasticity of Demand = (% Change in Quantity Demanded) / (% Change in Income)

In this case, the income elasticity of demand would be:

Income Elasticity of Demand = (20% / 10%) = 2

This indicates that the demand for cars is highly elastic with respect to income, meaning that a small change in income results in a relatively large change in the quantity demanded for cars.

Explanation:

Income elasticity of demand measures the responsiveness of demand for a product to a change in income. In this case, we see that the demand for cars increases by 20% when the income of the household increases by 10%, indicating that cars are a normal good.

The income elasticity of demand value of 2 means that for every 1% increase in income, the demand for cars will increase by 2%. This indicates that cars are a luxury good as the increase in demand for cars is proportionally larger than the increase in income.

As the income elasticity of demand is greater than 1, we know that the demand for cars is elastic with respect to income. This means that the quantity demanded for cars is highly responsive to changes in income. As a result, car manufacturers and dealerships may need to adjust their pricing strategies and marketing campaigns to cater to changes in income levels of households.

Conclusion:

In conclusion, the income elasticity of demand is a crucial concept for businesses to understand as it helps them to predict changes in demand for their products based on changes in income levels of their target consumers. In this case, we see that the demand for cars is highly responsive to changes in income, indicating that car manufacturers and dealerships need to remain aware of changes in income levels in order to adjust their strategies accordingly.