Question

Using the midpoint method:

1. Compute the income elasticity of good Z. State what kind of good Z is (inferior, necessity, or luxury?) (7 marks)

Hint: To obtain the effect of Income only, you need to look for where income is changing, but prices of Y and Z are constant.

2. Compute cross-price elasticity of demand for good Z with respect to the price of good Y. State if goods Y and Z are complements or substitutes (7 marks)

Hint: you need to look for where the price of Y is changing, but the income and price of Z are constant.

3. What would happen to the quantity of Good Z if income increases, and the price of Y decreases? (increase, decrease, or ambiguous?)Briefly explain (no computation needed) (6 marks)

Hint: consider the two effects one by one. What happens to the Quantity of Z when income increases? Then what happens to the quantity of Z when Price of Y decreases? Then put the two effects together to suggest a net effect.

Income	Quantity of Good Y Purchased	Quantity of Good Z Purchased	Price of GoodY	Price of Good Z
$35,000	25	20	16	30
$35,000	35	15	10	30
$45,000	45	18	10	30

Answer 1