2. Fraol’s income elasticity for good A is equal to -1.5. His current income is Br.40, 000 per year and he buys 200 units of good A annually. If his income falls to Br.36, 000 how many units of good A will he purchase?

230

Explanation:

Good A has an income elasticity of -1.5.  The goods is an inferior good since it has a negative income elasticity. An increase in income reduces its demand, but a decline in income increases its demand.

Fraol’s income has decreased. He will demand more of good A.

the formula for calculating income elasticity is as follows

Income elasticity of a good = % Change in demand/ % change in income.

i.e - 1.5 = % Change in demand/ % change in income.

% change in income =( 40,000 -36,000)/40,000 x 100

=4,000/40,000 x 100

=10%

-1.5 = %CD/10

%CD= 10 x -1.5

%change in demand = 15%

the new demand will be( 15% x 200 ) + 200

=(15/100 x 200 )+200

=(0.15x200) +200

=30 +200

=230

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