Question

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6. Using the income elasticity of demand to characterize goods Data collected from the economy of Cardtown reveals that a 14% decrease in income leads to the following changes: . An 11% increase in the quantity of spades demanded . A 2% decrease in the quantity of chips demanded . A 27% decrease in the quantity of diamonds 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.) Good Income Elasticity of Demand Normal or Inferior Good 0.79 Y 0.14 ▼ -0.52 Normal ▼ Inferior Inferior ▼ Chips Diamonds

Answer 1

Income elasticity of demand = Percentage change in Quantity demanded/Percentage change in income Percentage change in income = -14% calculating income elasticity of demand (a) spades = 11/- 14 = -0.79 rightarrow Inferior good (b) chips = -2/- 14 = 0.14 rightarrow Normal good (c) Diamonds = -27/ - 14 = 1.93 rightarrow Normal good. A good is Normal good if income elasticity of demand is positive and inferior good if income elasticity of demand is Negative. Diamonds are most likely to be classified as luxury goods because for luxury goods, income elasticity of demand is greater than one.