Question

5. A survey found that when incomes increased by 10%, the following changes in quantities demanded occurred: spring water up by 5%; sports drinks down by 2%; cruises up by 15%.

I) Calculate income elasticity for spring water. Is it a normal good, an inferior good, or a luxury good?

II) Calculate income elasticity for sports drinks. Is it a normal good, an inferior good, or a luxury good?

III) Calculate income elasticity for cruises. Is it a normal good, an inferior good, or a luxury good?

Answer 1

Solution: Increase in income = 10%

Quantity demanded of spring water increases by 5%

Quantity demanded of sports drink decreases by 2%

Quantity demanded of cruises increases by 15%

I) Income elasticity of spring water is given by:

Income elasticity of demand = (% change in spring water demanded)/(% change in income)

Income elasticity of demand = 5%/10% = 5/10

Income elasticity of demand = 1/2 = 0.5

Since the income elasticity of demand of spring water is positive equal to 0.5 which is in between 0 and 1, it means that as income gets increased there is also an increase in the quantity of spring water demanded at each price level.

Such goods are normal goods whose consumption is not affected by the change in income levels.

For example: tootpaste, vegetables are normal goods.

II) Income elasticity of sports drink is given by:

Income elasticity of demand = (% change in sports drinks demanded)/(% change in income)

Income elasticity of demand = -2%/10% = -2/10

Income elasticity of demand = -1/5 = -0.2

Since the income elasticity of demand of sports drink is negative equal to 0.2 it means that as income gets increased there is a decrease in the quantity of sports drink demanded.

Such goods are inferior goods whose consumption decrease as there is an increase in income levels because people like to upgrade to better quality products.

III) Income elasticity of cruise is given by:

Income elasticity of demand = (% change in cruise demanded)/(% change in income)

Income elasticity of demand = 15%/10% = 15/10

Income elasticity of demand = 1.5

Since the income elasticity of demand of cruise is positive equal to 1.5 and it is greater than 1, it means that as income gets increased there is also an increase in the quantity demanded of cruise because people like to enjoy the luxury.

Such goods are luxury goods whose consumption increases as the income levels increase.