Answer to Question #204032 in Microeconomics for Ooi Siew Lee

Question

a. During 2009, incomes fell sharply due to the financial crisis of 2008-2009. This change likely led to a decrease in the prices of both normal and inferior goods.

Answer 1

The normal goods are goods which demand increases with increase in income that means income effect is positive and income elasticity is positive. The inferior goods are goods which demand falls with a rise in income that means income effect is negative and income elasticity is negative.

If the income fell sharply due to the financial crisis of 2008 – 2009, the demands for the normal good will decrease and for inferior good will increase. As a result, the prices of normal goods will decrease due to decreased demand and prices of inferior goods will increase due to increased demand.

So, the above statement is incorrect as the change likely led to fall in the prices of normal goods but increase in the prices of inferior goods.