Question

By observing an individual's behavior in the situations outlined below, determine the relevant income elasticities of demand for each good (i.e., whether it is normal or inferior). If you cannot determine the income elasticity, what additional information do you need? a. Bill spends all his income on books and coffee. He finds $\mathrm{\$}20$ while rummaging through a used paperback bin at the bookstore. He immediately buys a new hardcover book of poetry. b. Bill loses $\mathrm{\$}10$ he was going to use to buy a double espresso. He decides to sell his new book at a discount to a friend and use the money to buy coffee. c. Being bohemian becomes the latest teen fad. As a result, coffee and book prices rise by 25 percent. Bill lowers his consumption of both goods by the same percentage. d. Bill drops out of art school and gets an M.B.A. instead. He stops reading books and drinking coffee. Now he reads the Wall Street Journal and drinks bottled mineral water.

Short answer

Based on these scenarios, we can infer that books might be a normal good for Bill, while coffee might be inferior. However, as his behavior changes across situations marked by different changes in income, it is difficult to definitively categorize these goods without additional information. We would require further information about the precise changes in his income and how they affect his demand for both goods in a more consistent manner to make a final determination.

Step-by-step solution

Analyze Bill's response to found money

In scenario 1, Bill found extra money and immediately spent it on a book. In economic terms, his disposable income increased, leading him to buy more books, a normal good in this context.

Determine the response to a loss

In the second scenario, Bill lost money which he then made up for by selling a book and buying coffee instead. When his income declined, he reduced his demand for books and increased it for coffee. In this scenario, books appear to be a normal good and coffee an inferior one because its demand increased when his income reduced.

Consider the response to price changes

In the third case, despite the increased popularity of both coffee and books driving their prices up, Bill reduced his consumption of both. Regardless of increased prices, if goods were normal, the quantity demanded would remain constant or increase. However, in this case, we see a decrease in demand, indicating that these goods could be seen as inferior in this scenario. To provide a more accurate answer, we would need more information on his income at this point.

Analyze changes due to a major lifestyle change

In the final scenario, Bill has a significant lifestyle change, potentially resulting in an increase in income. He no longer buys any books or coffee, indicating these could be thought of as inferior goods. His demand for these goods decreased with an increase in his income.

Key concepts

Normal Goods

When it comes to understanding the dynamics of consumer behavior and market economics, the classification of goods plays a fundamental role. A key classification is that of normal goods, which are items for which demand increases as the consumer's income increases. This positive correlation between income and demand is a straightforward indicator of a normal good.

For instance, consider a scenario where an individual, let's say Bill from our exercise, receives an unexpected financial bonus. If Bill decides to spend this newfound wealth on an item – such as a hardcover book of poetry – it reveals a vital aspect of his consumer behavior. The increase in demand for books when Bill's disposable income rises suggests that, in his eyes, books are normal goods. This would typically be observed in products or services that are considered necessities or quality enhancements to one's lifestyle.

A broader understanding of this concept can help students delineate between types of goods and make predictions about market trends and consumer spending patterns as incomes fluctuate.

Inferior Goods

On the flip side of normal goods, we encounter inferior goods. These are goods whose demand decreases as the consumer’s income increases. It's a counterintuitive concept at first glance, but it bears significant implications for businesses and economists observing consumer behavior patterns.

In the context of our exercise, when Bill faces a loss of income and reacts by prioritizing the purchase of coffee over a book, it suggests that, for him, coffee might be an inferior good. Bill's inclination to replace the loss of what he initially deemed more valuable with coffee when his spending capacity is reduced is characteristic of consumer behavior surrounding inferior goods. Often, these goods are replaced by more expensive alternatives (premium goods) when a person's purchasing power increases. Recognizing inferior goods helps us understand how consumers might downgrade their consumption habits during economic downturns or personal financial losses.

Consumer Behavior

The cornerstone of economics lies within the scope of consumer behavior, as it provides invaluable insights into how individuals make purchasing decisions. Factors such as personal income, societal trends, and lifestyle changes significantly influence the types of goods consumers buy and in what quantities.

Our exercise's protagonist, Bill, showcases varying consumer behaviors as he navigates through different financial and personal circumstances. For example, Bill's decision to lower his consumption of books and coffee following a price hike demonstrates his sensitivity to price changes—a common consumer reaction. Alternatively, when Bill undergoes a significant lifestyle change, such as getting an M.B.A., he alters his spending habits entirely, moving away from what he previously consumed.

Understanding and analyzing these kinds of consumer behaviors offer businesses and policymakers critical data to forecast market demand and frame economic policies. It also underscores the importance for students studying economics to grasp how income, preferences, and societal shifts interact to shape consumer markets.