Question

Jan is a graduate student who spends all her income on reading Kindle books on economics and drinking herbal tea. Books on Kindle cost her $8 each while boxes of her herbal tea cost $4. When Jan’s income is $100 per week, she reads 10 books on Kindle and buys 5 boxes of tea. After getting a raise at work, her income rises to $124 per week. With this, she now reads 12 economic books each week while going through 7 boxes of tea. Based on these figures, determine if the following are normal goods, inferior goods and/or luxury goods. Briefly explain your reasoning. [i.e., show the work behind your answer] a. Kindle Books on Economics b. Herbal Tea

Answer 1

(a)

Using midpoint method,

Income elasticity for Kindle books = (Change in demand for Kindle books / Average demand for Kindle books) / (Change in income / Average income)

= [(12 - 10) / (12 + 10)] / [(124 - 100) / (124 + 100)]

= (2 / 22) / (24 / 224)

= 0.85

Since Income elasticity is positive, this is normal good. Since income elasticity is less than 1, this is a necessity (and not luxury).

(b)

Using midpoint method,

Income elasticity for herbal tea = (Change in demand for herbal tea / Average demand for herbal tea) / (Change in income / Average income)

= [(7 - 5) / (7 + 5)] / [(124 - 100) / (124 + 100)]

= (2 / 12) / (24 / 224)

= 1.56

Since Income elasticity is positive, this is normal good. Since income elasticity is higher than 1, this is a luxury good.