Question

If our income elasticity for vacation trips is \(2.8\), we may conclude that vacation trips are (LOl) a) a normal service b) an inferior scrvice c) both a normal service and an inferior service d) neither a normal service nor an inferior service

Short answer

The income elasticity for vacation trips is \(2.8\), which is greater than \(1\). This indicates that vacation trips are a "normal good" and specifically a "luxury good", as the quantity demanded increases more than proportionately when income increases. Thus, the correct answer is (a) vacation trips are a normal service.

Step-by-step solution

Understand Income Elasticity of Demand

Income elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in income. It is given by the formula: \( Income \, Elasticity = \frac{\% \, Change \, in \, Quantity \, Demanded}{\% \, Change \, in \, Income}\) There are three possible outcomes based on the value of income elasticity: 1. If the income elasticity is greater than \(1\), the good or service is a "normal good" and particularly considered as a "luxury good" (income elasticity greater than \(1\) indicates that the quantity demanded of the good or service increases more than proportionately as income increases). 2. If the income elasticity is between \(0\) and \(1\), the good or service is a "normal good" but considered as a "necessity good" (quantity demanded increases, but to a lesser extent as income increases). 3. If the income elasticity is negative (less than \(0\)), the good or service is an "inferior good" (quantity demanded decreases as income increases).

Determine the Type of Good or Service Based on the Given Income Elasticity

We are given the income elasticity for vacation trips, which is \(2.8\). To determine if it is a normal or inferior service, we need to relate this value to the outcomes mentioned in Step 1. Since the value of income elasticity is \(2.8\), which is greater than \(1\), vacation trips are considered a "normal good" and specifically a "luxury good", as the quantity demanded increases more than proportionately when income increases.

Provide the Answer Based on the Given Options

Now that we know that vacation trips are a "normal good" and a "luxury good", we can assign it to the correct answer choice: a) a normal service So, the correct answer is (a) vacation trips are a normal service.

Key concepts

Normal Goods

Normal goods are an interesting category when it comes to consumer behavior. These are goods for which demand increases as consumer income rises. Imagine your paycheck has increased. You're more likely to buy more clothes, better gadgets, or perhaps take a few extra vacation trips. This is because your purchasing power has increased, and you're in a position to enjoy more goods.

When economists discuss normal goods, they often compare them to necessity and luxury goods. Although both fall under the umbrella of normal goods, the level at which demand increases differs. Essentially:

• Necessity goods have an income elasticity between 0 and 1. You might buy slightly more groceries or pay for better-quality healthcare.
• Luxury goods have an income elasticity greater than 1. This category covers things like high-end electronics, fine dining, and lavish vacations.

The defining feature of normal goods, including luxury and necessity goods, is that they become sought-after as our income grows.

Inferior Goods

Inferior goods can be a bit counterintuitive. These are goods where demand actually decreases as income rises. Let's break this down with an example. Suppose you rely on instant noodles when you're budgeting tightly. As your income grows, you might start dining out more or buying fresh ingredients for home-cooked meals instead. The crucial point here is that inferior goods tend to be low-cost alternatives that people forgo as they have more spending choices available. This makes understanding how inferior goods function vital, especially when evaluating changing market trends or consumer behavior. If a commodity sees decreased demand despite overall economic improvements, it might be classified as an inferior good.

Luxury Goods

Welcome to the world of luxury goods – the segment of the market that thrives as people start earning more. Luxury goods are characterized by an income elasticity greater than 1. Simply put, demand for these items increases more than proportionately with an increase in income. When you find yourself getting a pay raise, you might indulge in something like a designer handbag, a top model smartphone, or an exotic vacation. What's fascinating about luxury goods is that they often symbolize status and prestige. This often means they aren't just about functionality but also about exclusive experiences or ownership. As luxury segments continue to grow with economic development, businesses tap into consumer aspirations, creating offerings that promise a distinct, high-end lifestyle. Understanding luxury goods thus gives insight into market dynamics and consumer psychology.