income elasticity?

Question

. You are the manager of a supermarket, and know that the income elasticity of peanut butter is exactly -0.7. Due to the recession, you expect incomes to drop by 15% next year. How should you adjust your purchase of peanut butter?
a) buy 10.5% more peanut butter.
b) buy 2.14% more peanut butter.
c) buy 6.2% less peanut butter.
d) buy 9.8% less peanut butter.

Answer 1

Income elasticity refers to sensitivity of consumption of products with respect to their income. Like demand elasticity, it's simply a ratio of percent changes. In the case of income elasticity, it's the percent change in income over the percent change in the quantity:

Income elasticity=(delta income)/(delta quantity)

Just substitute the values:
Income elasticity=-.7
delta income=-.15
delta quantity=unknown (dQ)

-.7=-.15/dQ
dQ=-.15/-.7
dQ=+.105=+10.5%

Therefore the choice is a), buy 10.5% more peanut butter.

Answer 2

first, figure out what the new income will be in terms of the previous income. if the income drops, it will be 85% of what it is now.

next, take that and turn it into a decimal..... 0.85

then, multiply by -0.7 (the elastic demand) = -0.0062 = 6.2%

Answer 3

Mozart is right. ChrisS is wrong.

Elasticity of demand measures the chanfge in demand given the change in wealth. It does not take the total wealth into account.