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Data collected from the imaginary economy of Ilium reveals that an 18% increase in income leads to the following changes: a 29% increase in the quantity of marpod demanded; a 17% decrease in the quantity of degdan demanded; and a 14% increase in the quantity of sogem demanded
Data collected from the imaginary economy of Ilium reveals that an 18% increase in income leads to the following changes: a 29% increase in the quantity of marpod demanded; a 17% decrease in the quantity of degdan demanded; and a 14% increase in the quantity of sogem demanded. (a.) Compute the income elasticity of demand for each of the goods described. (b.) Determine whether the income elasticity for each good indicates that it 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 important information is conferred by the sign. (c.) Which of the three goods is most likely to be classified as a luxury good?
Expert Solution
(a.) The income elasticity of demand (E(inc)) for a commodity is defined as follows:
- E(inc) = (% change in the commodity)/(% change in income.
Using the formula, E(inc) can be calculated for each of the three goods.
Marpod
- E(inc) = 29%/18% = 1.61.
Degdan
- E(inc) = -17%/18% = -0.94
Sogen
- E(inc) = 14%/18% = 0.78.
(b.) A normal good is one that has a positive income elasticity. An inferior good is one that has a negative income elasticity. Therefore, marpod and sogen are normal goods and degdan is an inferior good.
(c.) A luxury good is one for which demand increases more than proportionally as income increases. This implies income elasticity greater than 1. Marpod would be classified as a luxury good since its income elasticity at 1.61 is far greater than 1.
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