Normal and Inferior
Goods
Questions
1. What are Normal and Inferior goods?
2. How are Normal and Inferior goods measured?
3. Normal goods are divided into necessities and luxuries. Give examples of both types of Normal goods and Inferior goods.
4. Explain why bus travel is an Inferior good.
5. Explain the division between necessities and luxuries in terms of demand.
6. Explain Necessities, Luxuries and Inferior goods in terms of Income Elasticity of Demand.
7. What is the Income Effect of a price change?
8. The effect on the demand for various goods following a price rise as a result of the income effect
9. What is a Giffen good?
10. In terms of Giffen goods, explain how the ‘potato famine’ theory was debunked and the ‘Chinese rice’ theory.
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Normal and Inferior
Goods
Answers
1. A normal good is one where its demand rises as consumers’ income rises. There is a positive relationship between real
income and the demand for the good in question. With inferior goods, there is an inverse relationship between real income
and the demand for the good in question. If real incomes rise, the demand for an inferior good will fall. If real incomes fall (in
a recession, for instance), the demand for an inferior good will rise.
2. Normal and Inferior goods are measured by income elasticity of demand (IED). Normal goods have a positive IED and
inferior goods have a negative IED.
3. Necessities are items such as Basic foodstuffs, including bread, tea, fruit and green vegetables, while, as you would expect,
luxuries are goods such as foreign holidays, fast cars, meals out and fine wines. Types of Inferior goods are frozen
vegetables, cigarettes, processed cheese, tinned meat and bus travel.
4. As people get richer, they are more likely to buy themselves a car, or use a taxi, rather than rely on the more inferior bus, so
the demand for bus travel falls as real incomes rise.
5. Necessities are defined as goods where the demand for these goods does not rise significantly as a result of an increase in
real incomes. Bread for example: if someone’s real income doubles overnight, they would not buy twice as much bread. A
luxury however, is treated differently. If real incomes in the UK rise quite significantly, the demand for things like fast cars
tend to rise at an even faster rate
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Normal and Inferior
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6. See Box:
The Income Elasticity of Demand (IED) measures the responsiveness of demand to a change in income.
e.g. if your income increase by 5 % and your demand for mobile phones increased 20% then the IED = 20/ 5 = 4.
IED = % change in Quantity of Demand
% change in Income
INFERIOR GOOD
When the change in Quantity of Demand is less than the change in Income, the IED<0. This occurs when an increase in income
leads to a fall in demand.
NECESSITY
When the change in Quantity of Demand is more than the change in Income, The IED>0. This occurs when an increase in
income leads to an increase in demand. If the IED rests between 0 and 1 (0 < IED < 1), the good is considered a necessity.
LUXURY GOOD
When the change in Quantity of Demand is more than the change in Income, The IED>0. This occurs when an increase in
income leads to an increase in demand. If the IED is greater than 1 (IED > 1), the good is considered a luxury.
Source: http://www.economicshelp.org/microessays/equilibrium/income-elasticity-demand.html
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Normal and Inferior
Goods
7. The income effect of a price change is when the price of a good rises, the consumer’s real income falls. If prices increase, the
amount that a consumer can really buy has fallen thereby making their real income fall.
8. See box:
The effect on the demand for various goods following a price rise as a result of the income effect will depend on whether the
good in question is normal or inferior. Following the price rise, real incomes fall, so for a normal good the income effect will
cause the demand for the good to fall (because of the positive income elasticity). For an inferior good, the fall in real income will
lead to a rise in the demand for the good as a result of the income effect (because of the negative income elasticity).
Source: http://www.scool.co.uk/topic_quicklearn.asp?loc=ql&topic_id=3&quicklearn_id=9&subject_id=11&ebt=43&ebn=&ebs=&ebl=&elc=13
9. See box:
A Giffen good is a special type of inferior where quantity demanded rises when price rises. For most products, price elasticity of
demand is negative. In other words, price and demand pull in opposite directions; if price goes up, then quantity demanded goes
down, or vice versa. Giffen goods are an exception to this. Their price elasticity of demand is positive. When price goes up, the
quantity demanded also goes up, and vice versa.
Source: http://en.wikipedia.org/wiki/Giffen_good
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Normal and Inferior
Goods
10. See box:
These “Giffen goods” show up in every introductory economics textbook as a freak case when the law of demand fails. Legend
describes the Irish potato famine as a possible example: as the price of potatoes rose, people were so poor that they started
substituting potatoes, a dietary staple, for meat and other unnecessary luxuries. The Irish consumed more potatoes as a result.
The trouble with this example is that Ireland was having a famine. The rising potato price was almost certainly caused by a
supply shortage, making it highly unlikely that people were able to consume more of them. That has not stopped generations of
textbook writers from using this particular example. Now, they can finally switch to a case with a bit more proof behind it.
Jensen and Miller look at poor Chinese consumers and demonstrate that they consume more rice or noodles, their staples, as
prices go up. The idea is the same as with the proverbial poor Irish. People need a certain amount of calories to survive—let’s
say 1600 per day. You can either get that by consuming rice and perhaps some vegetables alone, or by eating rice, vegetables
and a few bites of meat.
But meat is expensive. As the price of rice goes up, these poor Chinese can no longer afford the luxury of cooking meat, yet they
still need to get to their 1600 calories. So they eat rice instead, which is still relatively cheap compared to meat. Voila!: Giffen
behaviour in action.
Source: http://www.economist.com/blogs/freeexchange/2007/07/as_price_goes_up_so_does_deman.cfm
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