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 Pokerville reveals that a 16% increase in income leads to the following changes: . A 12% increase in the quantity of horses demanded . A 14% decrease in the quantity of spades demanded . A 28% increase in the quantity of diamonds 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

Income elasticity is the percentage change in quantity demanded for a given percentage change in income. Goods having an elasticity of less than 0 is said to be an inferior good. Goods having an elasticity between 0 and 1 is said to be normal good and the goods having an elasticity of greater than 1 is said to be a superior good.

Income elasticity = % change in quantity demanded / % change in price

Income elasticity = 12% / 16% = 0.75

Income elasticity = - 14% / 16% = - 0.875

Income elasticity = 28% / 16 % = 1.75

Horses Elasticity = 0.75         Normal

Spades    Elasticity = - 0.875   Inferior

Diamonds        Elasticity = 1.75        Superior / Luxury

Among the three goods, diamonds is most likely to be classified as a luxury good since it has an income elasticity greater than 1.

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