Question

Income rises from $3,500 to $4,000 a month and the quantity demanded of good X falls from 7 to 5 units a month. Income elasticity of demand (for good X) is __________ and good X is a(n) __________ good.
a. 0.40; normal
b. 2.50; normal
c. -2.28, inferior
d. 0.40; normal
e. -2.50;inferior

Answer 1

Answer:

E) -2.50 ; inferior

Explanation:

Before you earned $3,500 per month, you consumed 7 units per month. That means that you consumed 1 unit every $500 earned.

When your income increased to $4,000, you only consumed 5 units per month. That means that your consumption decreased to 1 unit for every $800.

The income elasticity of demand using the midpoint method is calculated by using the following formula:

income elasticity = {change in quantity demanded / [(old quantity + new quantity) / 2]} /  {change in income / [(old income + new income) / 2]}  

= {-2 / [(7 + 5) / 2]} /  {500 / [(3,500 + 4,000) / 2]} = (-2 / 6) / (500 / 3,750) = -0.333 / 0.133 = -2.5

Since the income elasticity of demand is negative, the good X is an inferior good.