Question

When the Shaffers had a monthly income of $4,000, they usually ate out 8 times a month. Now that the couple makes $4,500 a month, they eat out 10 times a month.
1. Compute the couple's income elasticity of demand using the midpoint method. Explain your answer.
2. Is a restaurant meal a normal or inferior good to the couple? Please show detailed calculations.

Answer 1

Answer:

1) income elasticity of demand = 1.89

2) Restaurant meals are normal goods, since the income elasticity of demand is positive.

Explanation:

Before when the Shaffers earned $4,000 per month, they ate out 8 times per month. That means they ate out 1 time for every $500 made.

When there income increased to $4,500, they ate out 10 times per month. That means they ate out 1 time for every $450.

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 / [(8 + 10) / 2]} /  {500 / [(4,000 + 4,500) / 2]} = (2 / 9) / (500 / 4,250) = 0.222 / 0.117 = 1.89

Answer 2

Explanation:

Income Elasticity of Demand(IED)= Percentage change in quantity demanded/ Percentage change in income

-Percentage change in Q:

%Change in quantity demanded= (q2-q1/q1) = (10-8)/8= 0.25

-Percentage change in Income:

%Change in income= (i2-i1/i1) = (4,500-4,000)/4,000= 0.125

IED= 0.25/0.125= 2

This indicates that the Shaffers are very sensitive to changes in income when it comes to eating out. Which means that changes in income will change significantly the number of times they eat out.

2. Restaurant meals are normal goods, in this case, because when income rises, they ate more in restaurants, then the units consumed for this good increase too.