The demand for wheat is price-inelastic and the income elasticity is positive but less than +1.0. Use this information to answer the following questions.

Question

The demand for wheat is price-inelastic and the income elasticity is positive but less than +1.0. Use this information to answer the following questions.

1. A) Holding everything else constant, if the price of wheat were to increase, would consumer spending on wheat increase, decrease or remain the same?
2. B) Is wheat a normal good or an inferior good?
3. C) As income increases over time, would the fraction of consumer income spent on wheat products increase or decrease? Briefly explain your answers.

Answer 1

Given: wheat is price inelastic (so the |P.E.D.| < 1) and the income elasticity of demand (IED) > 0, but less than 1.

a) If the Pwheat increases, then the quantity demanded of wheat falls, but falls by a smaller percentage than the increase in the price of wheat (since wheat is inelastic). The total spending on wheat = P*Q, and since the increase in P is "larger" than the decrease in Q, total spending increases.

b) As income rises, the positive IED tells us that quantity demanded of wheat also will rise, so wheat is a NORMAL good.

c) As income increases over time, because the IED < 1, the percentage increase in quantity demanded will be less than the percentage increase in income. This means that wheat will become a smaller and smaller part of the person's overall budget over time (i.e. the fraction of consumer income spent on wheat will decrease over time).

Note: All of these answers can be demonstrated numerically if you pick explicit values for the PED and IED. Try PED = -0.5 and IED = 0.8. Then suppose in parts and c that the percentage increases in price and income are both 10%.