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Chapter 4: Problem 10

By observing an individual's behavior in the situations outlined below, determine the relevant income elasticities of demand for each good (i.e., whether it is normal or inferior). If you cannot determine the income elasticity, what additional information do you need? a. Bill spends all his income on books and coffee. He finds \(\$ 20\) while rummaging through a used paperback bin at the bookstore. He immediately buys a new hardcover book of poetry. b. Bill loses \(\$ 10\) he was going to use to buy a double espresso. He decides to sell his new book at a discount to a friend and use the money to buy coffee. c. Being bohemian becomes the latest teen fad. As a result, coffee and book prices rise by 25 percent. Bill lowers his consumption of both goods by the same percentage. d. Bill drops out of art school and gets an M.B.A. in stead. He stops reading books and drinking coffee. Now he reads the Wall Street Journal and drinks bottled mineral water.

Short Answer

Expert verified
From Bill's behavior, we can infer that for him books and coffee can be considered normal goods under small income changes. But with substantial income changes, books and coffee can act as inferior goods.

Step by step solution

01

Identify income change and corresponding change in demand for a product

Start by identifying when there is a change in Bill's income and whether this leads to an increase or decrease in demand for a particular product. In situation a, Bill finds $20 and immediately spends it on a book, indicating that books may be a normal good for him.
02

Analyze reactions to income loss

Analyze how the individual reacts to losing income. In situation b, Bill loses $10 which he planned on using to buy coffee. Instead of going without coffee, he sells his book to get money for it. This might indicate that for Bill, coffee is a normal good and books are inferior goods, as he's willing to give up a book to afford coffee.
03

Determine responses to price changes

Observe the reaction to price increase. In situation c, the prices of coffee and books both increase 25 percent and Bill lowers his consumption of both goods by the same percentage. Even though it doesn't relate to income elasticity directly, this scenario illustrates Bill's price elasticity of demand for these goods, which appears to be greater than 1 (elastic), because the proportionate decrease in quantity demanded is greater than the proportionate increase in price.
04

Identify reactions to long-term income changes

In situation d, it seems like Bill's income may have increased with his career change. He stops reading books and drinking coffee altogether, substititing these goods with the Wall Street Journal and bottled mineral water, suggesting that coffee and books can be considered inferior goods, while the Wall Street Journal and bottled mineral water are normal goods here.

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