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 Royal City reveals that an 18% decrease in income leads to the following changes: . A 12% increase in the quantity of clubs demanded . A 5% decrease in the quantity of flops demanded . A 23% decrease in the quantity of houses 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

Calculate income elasticity of demand for clubs -

% decrease in income = -18%

% increase in quantity demanded = 12%

Income elasticity of demand = % increase in quantity demanded/% decrease in income

Income elasticity of demand = 12/(-18) = -0.67

The income elasticity of demand for clubs is -0.67

The value of income elasticity of demand for clubs is negative. This is in case of inferior good.

So, clubs is inferior good.

Calculate income elasticity of demand for flops -

% decrease in income = -18%

% decrease in quantity demanded = -5%

Income elasticity of demand = % decrease in quantity demanded/% decrease in income

Income elasticity of demand = -5/(-18) = 0.27

The income elasticity of demand for flops is 0.27

The value of income elasticity of demand for flops is positive. This is in case of normal good.

So, flops is normal good.

Calculate income elasticity of demand for Houses -

% decrease in income = -18%

% decrease in quantity demanded = -23%

Income elasticity of demand = % decrease in quantity demanded/% decrease in income

Income elasticity of demand = -23/(-18) = 1.27

The income elasticity of demand for houses is 1.27

The value of income elasticity of demand for flops is positive. This is in case of normal good.

So, houses is normal good.

Following is the complete table -

Houses has the highest income elasticity of demand.

Thus, houses is most likely to be classified as luxury good.

Hence, the correct answer is the option (3) [Houses].

Good Income elasticity of demand Normal good or Inferior good Clubs -0.67 Inferior good Flops 0.27 Normal good Houses 1.27 Normal good

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