Question

Data collected from the economy of Royal City reveals that an 18% decrease in income leads to the following changes: A 6% decrease in the quantity of chips demanded A 17% increase in the quantity of spades demanded A 29% decrease in the quantity of houses 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. Which of the following three goods is most likely to be classified as a luxury good? Chips Houses Spades

Answer 1

Income elasticity of demand = Percentage change in quantity demanded divided by Percentage change in income

Chips: -6/-18 = +0.33. Normal good. The sign is positive

Spades : 17/-18 = -0.94. Inferior good. The sign is negative.

Houses : -29/-18 = 1.61. Luxury good. The sign is positive and income elasticity is greater than 1.

Houses. Luxury goods are goods for which demand increases more than proportionately to increase in income. For example, if income increases by 10%, demand increases by 15%, The proportion of income spend on luxury goods is also higher. When income increases, people spend a higher percentage of their income on luxury goods. The income elasticity of demand is positive and greater than 1.