Question

Princess Buttercup is very budget conscious shopper in the peasant market for goods. Below represent observations on various goods:

            1. The quantity of shields demanded decreased by 6%

            2. The quantity of bread demanded increased by 1%

            3. The quantity of peasant tops demanded increased by 40%

            4. The quantity of iron pots demanded decreased by 25%

            5. The quantity of firewood demanded increased by 3%

For each good, calculate the income elasticity if income were to increase by 5%. Then explain whether a good is normal or inferior. Define income elasticity.

Of the goods above, which of the above are most likely to be a luxury good(s)?

Answer 1

Income elasticity(I) - The income elasticity of demand for a good shows the responsiveness of the percentage change of the quantity demanded for a good for a percentage change of income.

  I = Percentage change in quantity demanded for a good / Percentage change in income

If,  I 0 , then the good is normal.

If,  I 0 , then the good is inferior.

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1. The income increased by 5%, and as a result, the quantity demanded of shields decreased by 6%.

The income elasticity of demand for shields = - 6% / 5% = -1.2

Here we see that, as the income rises, the quantity demanded for shield decreases. So, the income elasticity of demand for shields is negative, and thus, the shield is inferior good.

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2. The income increased by 5%, and as a result, the quantity demanded of bread increased by 1%.

The income elasticity of demand for bread = 1% / 5% = 0.2

Here we see that, as the income rises, the quantity demanded for bread also rises. So, the income elasticity of demand for bread is positive, and thus, the bread is normal good.

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3. The income increased by 5%, and as a result, the quantity demanded of peasant tops increased by 40%

The income elasticity of demand for peasant tops = 40% / 5% = 8

Here we see that, as the income rises, the quantity demanded for peasant tops also rises. So, the income elasticity of demand for peasant tops is positive, and thus, the peasant top is normal good.

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4. The income increased by 5%, and as a result, the quantity demanded of iron pots decreased by 25%

The income elasticity of demand for iron pots = - 25% / 5% = -5

Here we see that, as the income rises, the quantity demanded for iron pots decreases. So, the income elasticity of demand for iron pots is negative, and thus, the iron pot is inferior good.

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5. The income increased by 5%, and as a result, the quantity demanded of firewood increased by 3%

The income elasticity of demand for firewood = 3% / 5% = 0.6

Here we see that, as the income rises, the quantity demanded for firewood also rises. So, the income elasticity of demand for firewood is positive, and thus, the firewood is normal good.

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The luxury goods are the goods whose income elasticity of demand is greater than 1.

Of the goods above, the peasant top is the luxury good, whose income elasticity of demand is 8.

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