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 Pokerille reveals that a 16% increase in income leads to the following changes: ·A 6% increase in the quantity of flops demanded ·A 14% decrease in the quantity of clubs demanded ·A 29% increase in the quantity of aces demanded 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.)

Explanation / Answer

Working notes:

(a) Income elasticity = % Change in demand / % Change in income

(b) A good is normal (inferior) if its Income elasticity is positive (negative).

(c) A good is luxury good if its income elasticity is significantly higher than +1.

Therefore:

(1)

(i) Income elasticity, Flops = 6% / 16% = 0.375

Flops are Normal goods.

(ii) Income elasticity, Clubs = -14% / 16% = - 0.875

Clubs are Inferior goods.

(iii) Income elasticity, Aces = 29% / 16% = 1.8125

Aces are Normal goods.

(2) Aces are luxury good [Since Income elasticity is much higher than +1].

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