Data collected from the economy of Royal City reveals that a

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 diamonds demanded OM 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.) Income Elasticity of Demand Normal or Inferior Good Good Chips Spades Diamonds Which of the following three goods is most likely to be classified as a luxury good ? Session 57:C PM 2018

Solution

% Change in Income

% Change in Quantity Demanded

18% Decrease

6% decrease in Quantity of Chips

17% increase in Quantity of Spades

29% decrease in Quantity of Diamonds

Goods

% Change in QD

% Change in Income

Income Elasticity of Demand

Normal or Inferior Good

Chips

6% (Negative)

18% Decrease

0.33 (Positive)

Normal GOOD

Spades

17% (Positive)

0.94 (Negative)

Inferior Good

Diamonds

29% (Negative)

1.61 (Positive)

Normal Good

Diamond is considered as Luxury good as the income elasticity is greater than one.

The income elasticity of demand is positive for normal goods.

The income elasticity of demand is negative for inferior goods.

Luxury items have an elasticity of demand that is greater than 1.

The formula for calculating income elasticity of demand is the percent change in quantity demanded divided by the percent change in income.

% Change in Income	% Change in Quantity Demanded
18% Decrease	6% decrease in Quantity of Chips
17% increase in Quantity of Spades
29% decrease in Quantity of Diamonds