Income Elasticity

Question 1

Define ‘Income elasticity of demand’.

Answer 1

The responsiveness of demand to a change in income

Question 2

What’s ‘Discretionary expenditure’?

Answer 2

non-essential spending or spending that is not automatic

Question 3

What is ‘Excise duty’?

Answer 3

a government tax on certain goods, such as cigarettes, alcoholic drinks, and petrol that are solid in the country

Question 4

What is ‘Value-added tax (VAT)’?

Answer 4

tax on some goods and services - businesses pay value-added tax on most goods and services they buy and if they are VAT registered, charge value-added tax on the goods and services they sell.

Question 5

How is income elasticity of demand calculated?

Answer 5

Income elasticity of demand = change in quantity demanded / change in income.

Question 6

What does it mean if the income elasticity of demand is between +1 and -1?

Answer 6

If the value of income elasticity of demand is between +1 and -1, demand is said to be income inelastic.

Question 7

Give an example(s) of a necessity.

Answer 7

Examples of necessities include food in general, electricity, and water

Question 8

Explain why the demand for necessities is income inelastic.

Answer 8

Demand for necessities is income inelastic because these goods are considered basic needs that consumers must buy regardless of their income level.

Question 9

Provide examples of luxury goods.

Answer 9

Examples of luxury goods include air travel, satellite television, designer clothing, etc.

Question 10

Why is demand for luxury goods considered income elastic?

Answer 10

Demand for luxury goods is considered income elastic because spending on these goods is discretionary, meaning it is optional and depends on the consumer’s income level.

Question 11

How does the value of income elasticity indicate whether a good is normal or inferior?

Answer 11

• For normal goods, an increase in income results in an increase in the quantity demanded, leading to a positive value of income elasticity.
• For inferior goods, an increase in income results in a decrease in the quantity demanded, leading to a negative value of income elasticity.

Question 12

Why is it important for businesses to know the price elasticity of demand for their products?

Answer 12

• Price elasticity can help businesses predict the effect of a price change on total revenue.
• For example, if demand for a product is inelastic, a price increase will increase revenue.

Question 13

How can income elasticity help businesses respond to changes in the economy?

Answer 13

• Knowing the income elasticity of demand for their products allows businesses to respond to predicted changes in incomes.
• For example, a firm may increase production of a product if demand for it is income elastic and incomes are expected to rise

Question 14

Why do governments target goods with inelastic demand for taxation?

Answer 14

Governments target goods with inelastic demand for taxation because consumers are less likely to reduce their consumption of these goods in response to price increases, ensuring a stable source of revenue for the government

Question 15

How does a subsidy affect the supply of a good?

Answer 15

A subsidy increases the supply of a good by shifting the supply curve to the right

Question 16

Why are subsidies often given to farmers?

Answer 16

Subsidies are often given to farmers because demand for many food products is inelastic, so an increase in supply due to the subsidy will help keep food prices lower for consumers.

Question 17

Why do governments prefer to tax goods with inelastic demand?

Answer 17

Governments prefer to tax goods with inelastic demand because consumers are less likely to reduce their consumption of these goods in response to price increases, ensuring a stable source of revenue for the government