econs 2015

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May/June 2015 Paper 22

2 (a) Explain how economists measure the way in which

demand for a good changes when income changes and,

with the help of a diagram, show why some goods are

classified as ‘inferior goods’.

Income elasticity of demand (YED) is a numerical

measure of te responsi!eness of "uantity demanded

follo#in$ a can$e in income%

Income Elasticity of Demand &

Percenta$e can$e in te 'uantity Demanded

Percenta$e can$e in Income

Income elasticity of demand is positi!e for normal

$oods% is means tat #en real income increases te"uantity demanded for te $ood #ill rise% e consumer #ill

use an increase in income to *uy more of tat $ood%

+o#e!er te le!el of increase in "uantity demanded depends

on te positi!e !alue of te fi$ure% ,en te percenta$e of

increase in "uantity demanded is $reater tan te percenta$e

of increase in income te YED-1 it is said to *e income

elastic% ,ereas #en te percenta$e of increase in "uantity

demanded is $reater tan .ero *ut lesser tan te percenta$e

of increase in income te YED1 it is said to *e income

inelastic%

s so#n in i$ure 1 as income increases "uantitydemanded for te normal $ood increases%

Inferior $ood is defined as a $ood #ic a rise in

#ere #en real income rises tere #ill *e leads to a decline

in "uantity demanded for te $ood% e income elasticity

demand for inferior $oods is ne$ati!e% onsumers #ill *uy

lesser of te $ood #ic is deemed to *e inferior to tem

#en teir income rises%

Comment:

The focus of thisquestion is inferiorgood. Your answer hashowever given a moredetailed explanation onnormal good rather

than inferior good.

You are advised to

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s so#n in i$ure 2 as income falls "uantity demanded for

te inferior $ood increases%

2 (b) Discuss how useful goernments might find the

concepts of price and income elasticity of demand when

setting economic policy.

Price elasticity of demand (PED) is defined as te

numerical measure of te responsi!eness of "uantity

demanded of a $ood follo#in$ a can$e in price #ereas

Income elasticity of demand (YED) is a numerical measure

of te responsi!eness of "uantity demanded follo#in$ a

can$e in income%

Price elasticity of demand is useful to te $o!ernment

as it measures te can$e in demand #en price can$es%

is elps te $o!ernment in many #ays% or e3ample in te

case of ta3 re!enue it elps to predict te re!enue from

indirect ta3es% If te $o!ernment is tryin$ to raise more

re!enue trou$ indirect ta3es it sould consider increasin$

ta3 or implementin$ ta3es on $oods #ic a!e inelastic

demand% is is *ecause te decrease in "uantity demanded

for tat $ood #ill *e less tan proportionate compared to te

increase in price due to indirect ta3es% 4ot only tat

$o!ernment can also increase re!enue *y reducin$ ta3es on

$oods #it elastic demand%

ter tan tat PED is also elpful to te $o!ernment#en te $o!ernment is considerin$ de!aluation and

re!aluation of currency% or any $o!ernment considerin$

de!aluation or re!aluation of its currency to correct its

*alance of payments deficit or surplus te 6no#led$e of

PED is essential in order to predict te can$es in import

e3penditure as #ell as e3port re!enue follo#in$ te

de!aluation or re!aluation of currency%

4ot only tat PED is also important for te

$o!ernment in estimatin$ te can$e in te consumption of

demerit $oods #en ta3es are imposed% or e3ample iddemand for demerit $oods are i$ly inelastic ta3es imposed

This is not true. Lowertax per unit will alwayslead to lower tax revenue. You can prove

Please specify that it isthe PE for exports andimports.

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#ill a!e little impact on decreasin$ consumption tus tis

#ill ma6e te $o!ernment tin6 of oter metods in reducin$

consumption of demerit $oods% ter tan tat PED #ill also

so# ena*le te $o!ernment to 7ud$e te effecti!eness of a

su*sidy as it predicts te e3tent of increase in "uantity

demanded follo#ed *y any a fall in price fall #en a $ood issu*sidised%

Income Elasticity of Demand is useful in assessin$

te impact of can$es in income ta3% or e3ample #en

tere is a rise in income ta3 te $o!ernment can predict te

demand for inferior $oods to increase and demand for normal

$oods to decrease%

ter tan tat income elasticity of demand is useful

to te $o!ernment in a #ay #ere it can elp tem predict

#ic $oods #ill a!e an increase in demand as time $oes *y% or e3ample increasin$ income in a country may lead to

an increase in demand and consumption of automo*iles #it

tis information te $o!ernment can ma6e an informed

decision re$ardin$ #at are te suita*le pro7ects to *e decide

to underta6en as te real income of te people rises in

infrastructure pro$rams%

In conclusion *ot PED and YED is are useful to te

$o!ernment *ut te concept #ic is most useful #ill depend

upon te policy te $o!ernment aims to acie!e%

!s predicting thedemand of inferiorgood and normal gooduseful for government"Please explain.

oes the question as#which is more useful"

The question as#s: how useful are PED and YED to government insetting economic policies"

You have given su$cient points regarding the usefulness PE and YE%ut failed to identify the shortcomings of using PE and YE as aguideline for decision ma#ing.

&hen we discuss 'how useful( we would li#e to evaluate the

usefulness as well as the limitations. You are yet to discuss thelimitations) %ecause of this you are not a%le to draw a conclusion asrequired %y the question.

econs 2015

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