Question

The demand for an inferior good is \((\mathrm{LO1}, 2)\) a) positively related to its own price b) negatively related to income c) unaffected by consumer tastes and preferences d) insensitive to changes in prices of its complements

Short answer

The demand for an inferior good is negatively related to income, as when consumers' incomes rise, they tend to substitute inferior goods with higher-quality goods and services. Hence, the demand for inferior goods falls with an increase in income and vice versa. Therefore, the correct answer is b) negatively related to income.

Step-by-step solution

Statement a: Positively related to its own price

Inferior goods are those goods that have an inverse relationship with income - as income rises, the demand for these goods falls, and vice versa. However, their demand does not necessarily reverse its relationship with its price. Inferior goods behave just like normal goods in terms of price changes. When the price of the good increases, its demand will generally decrease, and when the price decreases, demand will increase. Therefore, this statement is incorrect.

Statement b: Negatively related to income

This statement accurately describes the demand characteristic of an inferior good. When consumers' incomes rise, they tend to substitute inferior goods in their consumption basket with higher-quality goods and services. Hence, the demand for inferior goods falls with an increase in income, and vice versa. So, the demand for inferior goods is negatively related to income, making this statement correct.

Statement c: Unaffected by consumer tastes and preferences

This statement is not true for inferior goods, as tastes and preferences can affect the demand for all types of goods, including inferior goods. For instance, if a consumer's preferences shift towards a healthier lifestyle, they might avoid consuming a certain inferior good. So, consumers' tastes and preferences do impact the demand for inferior goods, making this statement incorrect.

Statement d: Insensitive to changes in prices of its complements

The demand for an inferior good can be affected by price changes of its complements, just like any other good. An increase in the price of a complementary good will make the entire bundle (both goods) more expensive, leading to a decrease in the demand for the inferior good as well. Similarly, a decrease in the price of a complementary good will encourage more consumption of the entire bundle, increasing the demand for the inferior good. Therefore, this statement is also incorrect. To conclude, the correct answer is: b) negatively related to income

Key concepts

Demand Elasticity

Demand elasticity refers to how sensitive the quantity demanded of a good is to a change in price. It shows whether demand for a product is elastic (resulting in a significant change in quantity demanded with a small price change) or inelastic (resulting in a small change in quantity demanded with a large price change).

Inferior goods, just like other goods, can exhibit varying levels of demand elasticity. If an inferior good is elastic, a decrease in its price could lead to a substantial increase in quantity demanded. Conversely, if it's inelastic, even significant price changes might have little effect on how much consumers buy.

Understanding demand elasticity helps businesses and economists make informed decisions about pricing strategies and forecast the effects of price changes on revenue.

Consumer Income Effect

The consumer income effect describes how changes in consumers' income levels impact their purchasing behavior, particularly in the context of inferior goods. As income increases, consumers often shift their spending from inferior goods to more luxurious or higher-quality options.

For example, when someone gets a pay raise, they might buy fewer branded store goods—considered inferior compared to nutritious, organic food—because they now can afford the latter.

• Increase in income generally results in decreased demand for inferior goods.
• Decrease in income can result in increased demand as consumers look for more cost-effective options.

Understanding the consumer income effect helps businesses predict changes in demand based on economic trends.

Complementary Goods

Complementary goods are products that are often consumed together. A change in the price or availability of a complementary good can directly affect the demand for its partner product.

When it comes to inferior goods, the demand can indeed change if the complementary good's price alters. For example, if the price of public transit (an inferior good for personal cars) rises, people may also cut back on related expenses like budget-friendly snack purchases.

• If the price of a complementary good rises, demand for both can decrease.
• If the price of a complementary good falls, demand for the pair can increase.

This interconnected relationship means that businesses should be aware of how pricing strategies in one area can ripple into others.

Consumer Preferences

Consumer preferences describe the tastes and preferences that dictate how consumers choose their products. These preferences can shift due to various factors like trends, advertising, and lifestyle changes.

Even for inferior goods, consumer preferences play a significant role. A consumer might choose instant noodles over more nutritious foods due to habit, taste, or convenience, regardless of income changes. However, if their preferences shift towards healthier options, even an increase in income might not sway them back to inferior goods.

• Preferences are influenced by culture, habits, and personal values.
• Preferences can change over time due to exposure to new information or lifestyles.

Thus, understanding consumer preferences is crucial for marketing strategies and product development.