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CA Foundation · Business Economics · Theory of Demand and Supply

The monthly income of Ramesh rises from ₹20,000 to ₹25,000, and his monthly purchases of branded packaged rice rise from 10 kg to 11 kg. Using the percentage (simple) method, the income elasticity of demand for packaged rice and the nature of the good are:

Income elasticity is 0.4, so the good is a normal good that is a necessity. Quantity rises 10% while income rises 25%, giving 10/25 = 0.4. A positive value indicates a normal good, and a value below 1 indicates a necessity.

  1. A0.4, a normal good that is a necessityCorrect
  2. B2.5, a luxury good
  3. C0.4, an inferior good
  4. D4.0, a luxury good

Explanation

Percentage change in quantity = 1/10 × 100 = 10%. Percentage change in income = 5,000/20,000 × 100 = 25%. Income elasticity = 10/25 = 0.4. It is positive, so the good is normal, and being less than 1 it is a necessity. Taking 25/10 = 2.5 inverts the ratio.

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