(15 points) By observing an individual\'s behavior in the situations outlined be
ID: 1150142 • Letter: #
Question
(15 points) By observing an individual's behavior in the situations outlined below, determine the relevant income elasticities of demand for each good (books and coffee), that is, whether each good is normal, neutral (zero income elasticity) or inferior. If you cannot determine whether a good is normal, neutral or inferior, what additional information do you need? (a) (5 points) Bill spends all his income on books and coffee. He finds $20 while rummaging through a used paperback bin at the bookstore. He immediately buys a new hardcover book of poetry (b) (5 points) Bill loses $10 he was going to use to buy a double espresso. He decides to sell his new book to a friend and use the money to buy the double espresso. (c) (5 points) 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.Explanation / Answer
a) Coffee is a neutral good because even when income increased, Bill did not buy more coffee. Books are a normal good because Bill bought more goods when income increased.
b) Book is a normal good because demand decreased when income decreased. Coffee is a neutral good as Bill's demand for coffee did not change when his income decreased or increased.
c) We cannot determine if books and coffee are normal, neutral or inferior. We do not know why his tastes and preferenes have changed.
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