Normal Goods vs. Inferior Goods
Goods can be classified as normal goods or inferior goods. This classification has nothing to do with the quality of a good, but rather with whether we buy more or less of a good depending on our income.
Most goods are normal goods. Generally, if a person experiences an increase in income, the person will purchase more normal goods. An example of a normal good is movie tickets.
It's different with inferior goods. Generally, if a person experiences a decrease in income, the person will purchase more inferior goods because it is more cost-effective to do so. Examples of inferior goods are generic items and used items.
Demand Elasticity
Elasticity measures how sensitive consumers are to price change.
- Demand is elastic when a change in price causes a large change in demand.
- Demand is inelastic when a change in price causes a small change in demand.
- Demand is unit elastic when a change in price causes a proportional change in demand.
Determinants of Demand Elasticity
There are three questions about a product that give us a reasonably good idea about a product's demand elasticity.
1. Can the purchase be delayed? Some purchases cannot be delayed, regardless of price changes.
2. Are adequate substitutions available? Price changes can cause consumers to substitute one product for a similar product. If an item has many close substitutes it tends to have an elastic demand because consumers can switch among substitutes.
3. Does the purchase use a large portion of income? Demand elasticity can increase when a product commands a large portion of a consumers income.
The Total Expenditures Test
Understanding the relationship between elasticity and profits can help producers effectively price their products.
Price x Quantity = Total Expenditures
Review
1. Explain the three determinants of demand elasticity.
2. Explain why an item that has many close substitutes tends to have an elastic demand.