Using income elasticity of demand, explain the difference between normal, necessity, and inferior goods.

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Paper 1 Essay Practice Question

Using income elasticity of demand, explain the difference between normal, necessity, and inferior goods.

        Income elasticity of demand is a measure of how much the demand for a product changes when there is a change in the consumer’s income. Quantity demanded is the total amount of goods or services that are demanded at any given point in time. Income elasticity of demand is usually calculated using the equation

YED = Percentage change in quantity demanded of the product

         Percentage change in income of the consumer

For example, a person has an increase in annual income from $10,000 per year to $11,000 and he then increases his annual spending on branded clothes from $1,000 to $1,200. With this information, the income elasticity of branded clothes can be calculated.

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His income has risen by $1,000 from an original income of $10,000, which is a change of +10%. This can be calculated by the equation

        (+1,000/10 000) x 100% = +10%.

The quantity demanded of branded clothes has increased by $200 from an original demand of $1,000, which is a change of +20%. This can be calculated by the equation

        (200/1,000) x 100% = +20%.

When the two values are substituted into the equation for income elasticity of demand, we end up with (+20%/+10%) which provides the value of +2.

        The ...

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