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IAI Actuarial Core Principles · Business Economics · Consumer demand and behaviour

Household income in a city rises by 8%, and demand for term life insurance policies from those households rises by 12%. Demand for a basic savings-linked sachet product falls by 4%. Which statement is correct?

Term insurance has an income elasticity of 1.5 (12% divided by 8%), so it is a normal good with elastic demand to income. The sachet product has -0.5 (-4% divided by 8%), so it is an inferior good.

  1. ATerm insurance is a normal necessity with income elasticity 1.5; the sachet product is a normal good
  2. BTerm insurance is a luxury-type normal good with income elasticity 1.5; the sachet product is an inferior good with income elasticity -0.5Correct
  3. CTerm insurance has income elasticity 0.67; the sachet product is a Giffen good
  4. DTerm insurance is an inferior good; the sachet product has income elasticity 0.5
  5. Term insurance has income elasticity 1.5; the sachet product has income elasticity -2

Explanation

Income elasticity for term insurance = 12/8 = 1.5, which exceeds 1, so it is a normal good with income-elastic demand. For the sachet product it is -4/8 = -0.5, negative, so it is an inferior good. Option 2 inverts the first ratio and wrongly calls the product a Giffen good.

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