7. Using the income elasticity of demand to characterize goods Data collected fr

Question

7. Using the income elasticity of demand to characterize goods

Data collected from the economy of Cardtown reveals that a 19% decrease in income leads to the following changes:

Compute the income elasticity of demand for each good and use the dropdown menus to complete the first column in the following table. Then, based on its income elasticity, indicate whether each good is a normal good or an inferior good. (Hint: Be careful to keep track of the direction of change. The sign of the income elasticity of demand can be positive or negative, and the sign confers important information.)

Which of the following three goods is most likely to be classified as a luxury good ?

Horses

Houses

Clubs

• A 26% decrease in the quantity of houses demanded • An 8% increase in the quantity of clubs demanded • A 1% decrease in the quantity of horses demanded

Explanation / Answer

Answer : Income elasticity of demand = % Change in quantity demanded/ % Change in income

As per information :

Income decreases = -19%

Change in quantity of houses demanded decreases = -26%

Change in quantity of club demanded increases = +8%

Change in quantity of horses demand decrease = -1%

Answer : Houses are classified as more Luxury good because as income decreases, the demand decrease at greater phase as compare to club and horses.

Goods Income elasticity of demand Normal or Inferior good Houses =-26%/-19% = 1.368 Luxury good Clubs = 8%/ -19%= -0.42 Inferior good Horses = -1%/ -19% = 0.052 Normal good

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