Question

1. A worker eats at a restaurant once a week. He then gets a 25% raise. As a result, he decides to eat out twice as much as before and cut back on the number of frozen pizza he eats from two every week to one every week. Determine the income elasticity of demand for eating at a restaurant and for eating frozen pizza. Determine if either is a normal good or an inferior good. You must show your work to receive full credit.

 2. Using the midpoint method, compute the elasticity of demand between points A and B. Is demand along this portion of the curve elastic or inelastic? Now compute the elasticity of

 demand between points B änd C. Is demand along this portion of the curve elastic or inelastic? You must show all of your work.

Answer 1

1.

Income elasticity of demand tells us how the demand for a good changes due to change in income, other things remaining the same.

A positive income elasticity of demand stands for a normal (or superior) good. When the quantity demanded of a product or service decreases in response to an increase and increases in response to decrease in the income level, the income elasticity of demand is negative and the product is an inferior good.

Income elasticity of demand=

% change in quantity demanded/% change in consumers income.

% change in consumer income is 25%.

% change in quantity demanded (eating out)=200%

% change in quantity demanded (eating frozen pizzas)=(1-2)/2=1/2=-50%.

Income elasticity of demand for eating out= 200%/25%=8. Income elasticity of demand is positive it is a normal good.

Income elasticity of demand for eating frozen pizzas= -50%/25%=-2. Income elasticity of demand is negative. It is an inferior good.

Answer 2

In this question a worker gets a 25% (or 0.25) raise, so we can use this

information in the denominator when determining the income elasticity of demand. We

are not given the percentage change for the meals out, so we need to plug in how often

thew worker ate out before (once a week) and the amount he eats out after the raise

(twice a week) in the numerator. Which gives us 2.67