5. Maria has decided always to spend one-third of her income on clothing
a) What is her income elasticity of clothing demand ?
b) What is her price elasticity of clothing demand ?
c) If Maria's tastes change and she decides to spend only 1/4 of her income on clothing,how does her demand curve change? What is her income elasticity and price elasticity now?
Ans:
a) Her income elasticity of clothing demand will be 1. This is because since she is spending a constant fraction of her income, her percentage change in clothing demand must equal to her percentage change in income. Suppose her income is $6000 and price of clothing is $2, then she buys 1000 clothes. If her income rises by 5% it becomes 6300 and she buys 1050 clothes, a 5%increase in demand.
b)The price elasticity of her clothing demand will also be 1. An increase in the price of clothes would lead to reduce her purchase by the same percentage. Suppose the price of clothing is $2 and her income is $6000, she will buy 1000 clothes. If the price increases by 1%, she will buy 990 clothes which is a 1% reduction.
c) Since she will now spend less on clothes, for any given price she will buy less clothes. He demand curve will shift to the left . But becasue she will still spend a fixed portion of her inclome on clothing, her income and price elasticity of demand will still be 1.