Question

During a very bad recession the nation's disposable income fell by 10 percent, while its consumption of a certain good rose by 5 percent. That good was good. (LO4) a) a complementary b) a substitute c) a normal good d) an inferior good

Short answer

During the recession, the nation's disposable income fell by 10 percent, while its consumption of a certain good rose by 5 percent. Based on the analysis, it is most likely that the good in question is (d) an inferior good.

Step-by-step solution

1. Understand the terminology

We need to comprehend the given terms and their interrelationships: - Disposable income: The income available to an individual after accounting for taxes and other deductions. - Consumption: The purchase and use of goods or services by households or individuals. - Complementary good: A good consumed together with another good. When the demand for one good increases, the demand for the complementary good usually increases too. - Substitute good: A good that can serve as an alternative to another good, meeting the same needs or wants. When the demand for one good increases, the demand for a substitute good typically decreases. - Normal good: A good for which consumption increases when disposable income increases, holding all other factors constant. - Inferior good: A good where consumption decreases as disposable income increases, holding all other factors constant.

2. Analyse the effect of a decrease in disposable income on consumption

The given exercise states that during the recession, there was a 10% decrease in disposable income, which resulted in a 5% increase in consumption of a certain good. This is an important clue: if consumption increases despite a decrease in disposable income, the good must have a negative income elasticity. Now, let's consider each type of good and determine if they fit in this scenario.

3. Assess complementary goods

A complementary good's consumption typically increases when the demand for another good increases. However, the exercise only provides information about disposable income and consumption; it doesn't provide enough information to evaluate complementary goods. Therefore, we cannot draw any conclusions about this option.

4. Assess substitute goods

A substitute good usually sees a decrease in consumption when the demand for another good increases. The decrease in disposable income can indeed impact the demand for certain goods, making people switch to substitutes. However, the exercise doesn't provide information about other goods that could be substituted. Therefore, we cannot draw conclusions about this option either.

5. Assess normal goods

A normal good would generally see an increase in consumption as disposable income increases. Since this exercise observes a decrease in disposable income, it would suggest that this good is not a normal good, as consumption increased rather than decreased.

6. Assess inferior goods

For inferior goods, consumption decreases as disposable income increases. This means that when disposable income decreases, an inferior good's consumption may increase. In the given exercise, a 5% increase in the good's consumption is observed when disposable income decreases, fitting the description of an inferior good. After analyzing the four options (a) complementary, (b) substitute, (c) normal good, and (d) inferior good, we can conclude that:

7. Conclusion

During the recession, the nation's disposable income fell by 10 percent, while its consumption of a certain good rose by 5 percent. Based on the analysis, it is most likely that the good in question is (d) an inferior good.

Key concepts

Income Elasticity

Income elasticity measures how demand for a certain good reacts to changes in income. When understanding income elasticity, we consider how sensitive demand is to income changes.

Generally, we categorize goods based on their income elasticity:

• Normal Goods: These have a positive income elasticity, meaning that as income rises, demand for these goods increases. Examples include luxury cars, branded clothing, and dining at upscale restaurants.
• Inferior Goods: These have negative income elasticity, meaning as income falls, demand for these goods rises. People often buy more of these when they earn less. Examples include discount store products or cheaper food alternatives.

Understanding income elasticity helps in predicting how economic changes might affect the demand for goods, which is crucial for businesses and policymakers.

Disposable Income

Disposable income is the amount of money a person has available after taxes and other obligatory charges. It is what's left to spend on necessities, save, or purchase non-essential goods. This concept is vital because it directly influences how people allocate their money to different spending areas.

For households:

• Increased disposable income: Leads to higher potential spending and savings, typically boosting economic activity.
• Decreased disposable income: Necessitates tighter budgeting, influencing consumption patterns heavily, especially in how goods are selected.

Knowing how disposable income affects spending can guide economic strategies, as seen in the scenario of income falling due to a recession, altering typical spending behavior.

Consumption Patterns

Consumption patterns refer to the trends and habits in how consumers purchase and use goods and services. These patterns can be influenced by several factors, including changes in income, preferences, and the economic environment. Understanding these patterns is essential for predicting consumer behavior.

Factors that affect consumption patterns include:

• Income Changes: As disposable income fluctuates, so do consumption habits. An increase may lead to more purchases of normal goods, while a decrease might shift preferences towards inferior goods.
• Economic Climate: During recessions, consumers often become more conservative with spending, prioritizing essential over luxury goods.
• Cultural and Social Influences: Trends and societal norms can dictate shifts in consumption patterns, affecting demand for specific goods over others.

By analyzing consumption patterns, businesses can tailor their strategies to meet consumer needs effectively, adapting to shifts caused by changes in income or economic circumstances.