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 flops demanded
•	A 14% decrease in the quantity of spades demanded
•	A 28% increase 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.)

Good	Income Elasticity of Demand	Normal or Inferior Good
Flops
Spades
Houses		Which of the following three goods is most likely to be classified as a luxury good ? Spades Houses Flops

Answer 1

Answer

Before calculating the income elasticity of demand for the given goods and their nature, let us have some idea about the income elasticity of demand.

The income elasticity of demand(_I) for a good shows the responsiveness of the change in quantity demanded for the good for the change in income. It is the ratio of the percentage change in the quantity demanded for a good and the percentage change in income.

If the change in quantity demanded for a good moves in the same direction of the change in income, then the good is called a normal good; like if income rises, then the quantity demanded of the good also rises.For the normal good, the value of income elasticity of demand is greater than '0'. The income elasticity of demand of this type of good may also be '0', if the quantity demanded doesn't change for the change in income.

On the basis of the value of income elasticity of demand(_I), the normal goods can be classified as normal necessary, and normal luxury goods.

For the normal necessary goods,the value of _I is between 0 and 1, i.e.,  0 _I1.

For the normal luxury goods,the value of _I is greater than 1( _I1).

If the change in quantity demanded for a good moves in opposite direction of the change in income, then the good is called an inferior good. For this type of good,if income rises, then the quantity demanded of the good falls, and vice versa.For the inferior good, the value of income elasticity of demand is less than '0'.

Now, in the given example,for the increase in income by 16%, the quantity demanded of flops increases by 12%.

For the increase in income by 16%, the quantity demanded of spades decreases by 14%.

For the increase in income by 16%, the quantity demanded of houses increases by 28%.

From the above analysis, we can now determine the income elasticity of demand for the given goods and their nature, that are summarized in the following table;

Good	Income elasticity of demand	Normal or Inferior Good
Flops	+(12% / 16 %) = +0.75; 1I0	Normal Good
Spades	-(14% / 16%) = -0.875; I0	Inferior Good
Houses	+(28% / 16%) = +1.75; I1	Normal Good

The houses here is a luxury good because its income elasticity of demand (_I) is greater than 1.

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