Question

If our income elasticity for vacation trips is \(2.8\), we may conclude that vacation trips are (LO1) a) a normal service b) an inferior service c) both a normal service and an inferior service d) neither a normal service nor an inferior service

Short answer

Since the income elasticity for vacation trips is positive (2.8), it indicates that as income increases, the quantity demanded for vacation trips also increases. This means vacation trips are a normal service. Thus, the correct answer is: a) a normal service

Step-by-step solution

Understand the income elasticity value provided

The income elasticity for vacation trips is given as 2.8. This value indicates the percentage change in the quantity demanded for vacation trips with respect to a 1% change in income.

Determine if the elasticity value indicates a normal or inferior service

Since the income elasticity is positive (2.8), it means that as income increases, the quantity demanded for vacation trips also increases. This indicates that vacation trips are a normal service.

Identify the correct answer choice

Based on our analysis, vacation trips are a normal service (not an inferior service, both, or neither). Therefore, the correct answer is: a) a normal service

Key concepts

Normal Service

In the realm of economics, services and goods can be classified based on how their demand changes in response to income variations. A normal service experiences an increase in quantity demanded when the income of consumers rises. In other words, as individuals have more disposable income, they tend to purchase more of these services. This relationship is quantified by income elasticity. When we talk about vacation trips with an income elasticity of 2.8, it suggests a strong positive response to income changes—people will demand substantially more vacation services as their income grows. This is why vacation trips are categorized as a normal service; they're often seen as a luxury that people spend on when they have extra income.

An excellent way to conceptualize a normal service is to think of it as something that enhances one’s quality of life or provides leisure and comfort, attributes that gain priority as financial constraints diminish. Examples other than vacation trips might include dining at fine restaurants, spa treatments, or subscription services for entertainment.

Inferior Service

Conversely, an inferior service is characterized by a decrease in quantity demanded as income rises. This might seem counterintuitive at first, but certain services are primarily consumed when one's budget is limited. These are typically substituted with more desirable services or goods when one's financial situation improves. If the income elasticity for a service is negative, it is a sign that the service in question is considered inferior in the economic context.

Take, for instance, public transportation. Many individuals may prefer using public transportation when their incomes are lower because it is a more cost-effective option compared to owning and maintaining a vehicle. However, as their income increases, they might choose to purchase a car or use rideshare services more frequently, reducing their reliance on public transportation. Therefore, increased income leads to a decreased demand for public transportation, marking it as an inferior service.

Quantity Demanded

The term quantity demanded refers to the specific amount of a service or good that consumers are willing to purchase at a given price point, during a certain period. It is an essential foundational concept in economics particularly when analyzing market behaviors and consumer purchasing patterns. Quantity demanded is not fixed; it fluctuates based on various factors, including price changes, consumer preferences, and income levels.

For example, if the price of a movie streaming service were to decrease, the quantity demanded for subscriptions may increase, as more consumers find the lower price attractive. This also interacts with income levels; as previously illustrated, income increases typically boost the quantity demanded for normal services while potentially decreasing it for inferior services.

Elasticity in Economics

The concept of elasticity in economics measures how sensitive the quantity demanded of a service or a good is to changes in other economic factors like price, income, or the price of related goods. Income elasticity, one of the types of elasticity, gauges the responsiveness of the quantity demanded for a service or good to a change in the consumer's income. Put simply, it's a way to predict how spending habits might change as people earn more or less money.

In the context of our vacation trips example, an income elasticity of 2.8 indicates high sensitivity to income changes—that the demand for vacation trips is quite responsive to changes in income. Generally speaking, if a good or service has an income elasticity greater than 1, it's considered to have high elasticity and is labeled a luxury; less than 1 but greater than 0 is still a normal good but less elastic; exactly 1 means unit elasticity; and less than 0 means it's an inferior good with negative income elasticity.