Question

7. Using the income elasticity of demand to characterize goods 

Data collected from the economy of Royal City reveals that a 16% increase in income leads to the following changes: 

. An 18% increase in the quantity of horses demanded 

. A 14% decrease in the quantity of spades demanded 

. A 30% increase in the quantity of aces 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.) 

Which of the following three goods is most likely to be classified as a luxury good? 

• Spades 

• Horses 

• Aces

Answer 1

a) As the income has increased and the and with it the quantity of horse demanded has also increased, horse income elasticity is 18/16 = 1.125 and horse is a normal good.

b) Spades has seen a decrease in the demand by -14% , that makes the income elasticity of spade = -14/16 = -0.875 and spade is an inferior good.

c) Aces demand has increased by 30% , income elasticity of aces is 30/16 = 1.875, an aces are normal good.

Luxury good are those whose income elasticity is more than 1. we can say Aces are most likely to the luxury good.

Answer 2

SOLUTION :

Horses :

Income elasticity of demand

= % change in demand / % change in income

= 18/16 

= 1.125 

Spaes :

Income elasticity of demand

= % change in demand / % change in income

= - 14/16 

= - 0.875  

Aces :

Income elasticity of demand

= % change in demand / % change in income

= 30/16 

= 1.875

Goods with ipositive ncome elasticity of greater than 1 are cllassified as normal goods and goods with negative elasticity of demand are termed as inferior goods.

So, we can formulate the following table :

Good.        Income Elasticity of Demand        Normal or Inferior Good

Horses                      1.125                                       Normal

Spades                    - 0.875                                      Inferior

Aces                          1.875                                       Normal

Aces will be most likely classified as luxury good as its income elasticity of demand is greater than one and highest among the above group.

(ANSWER).