Data collected from the economy of Cardtown reveals that an

Data collected from the economy of Cardtown reveals that an 18% decrease in income leads to the following changes: Help please • A 6% decrease in the quantity of horses demanded • A 17% increase in the quantity of spades demanded • A 29% decrease in the quantity of diamonds demanded

Good

Income Elasticity of Demand

Normal or Inferior Good

-3

-0.33

0.33

3

Normal

Inferior

-1.06

-0.94

0.94

1.06

Normal

Inferior

Diamonds                                                                                                                  

-1.61

-0.62

0.62

1.61

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

Horses

Diamonds

Spades

Solution

Before We solve the problem we have to know the formula of Inome elasticity of demand.

Income elaticity of demand is the percentage change in quantity demand to the percentage change in Income. One more thing we have to understand i.e. Negative income elasticity of demand assoctied with inferior goods and postive income elasticity of demand associated with normal goods.

In the positive elasticity demand case if it is less than one its a necessity and if it is more than 1 its a luxury goods.

In your question the given variables are as follows

Income 18% decrease

6% decerese in quantity of horses demanded

17% incerese in quantity of spades demanded

29% decerese in quantity of diamond demanded

Income elasticity demand = % change in demand for the good / % change in Income

Income elasticity demand for horses = -6%/-18% = 0.34 ( Normal Good)

Income elasticity demand for spades = 17%/-18% = -0.95 ( Inferior Good)

Income elasticity demand for diamond = -29%/-18% = 1.61 ( Normal Good as well as Luxury Good)

Diamond is most likely to be classified as a luxury good