Question

7. Using the income elasticity of demand to characterize goods Data collected from the economy of Cardtown reveals that a 13% increase in income leads to the following changes: • A 34% increase in the quantity of houses demanded • A 19% decrease in the quantity of clubs demanded • A 4% increase in the quantity of flops 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.) Good Income Elasticity of Demand Normal or Inferior Good Houses       Clubs       Flops       Which of the following three goods is most likely to be classified as a luxury good ? Clubs Flops Houses

Answer 1

A 13% increase in income leads to a 34% increase in the quantity of houses demanded would mean that the Houses are considered as a normal good. Income elasticity of demand equals percent change in quantity demanded divided by percentage change in income. A positive value of income elasticity and less than one means the good is a normal and a LUXURY good. Income Ed = 34/13 = 2.62

A 13% increase in income leads to a 19% decrease in the quantity of clubs demanded would mean that the clubs are considered as a inferior good. With increase in income the demand for clubs has decreased. Income elasticity of demand equals percent change in quantity demanded divided by percentage change in income. A negative value of income elasticity and less than zero means the good is a inferior good. Income Ed = -19/13 = -1.46

A 13% increase in income leads to a 4% increase in the quantity of flops demanded would mean that the flops are considered as a normal good. With increase in income the demand for clubs has increased. Income elasticity of demand equals percent change in quantity demanded divided by percentage change in income. A positive value of income elasticity and greater than zero but less than one means the good is a NORMAL good. Income Ed = 4/13 = 0.31