Definition of main terms
Normal goods are goods whose demand increases with an increase in consumers’ income. Note that the rate at which demand increases is lower than the rate at which income increases. The rate eventually slows down with further increases in income. Examples of goods are furniture, clothes, and automobiles.
These are goods whose demand decreases when the consumers’ income increases. Examples could be second-hand clothes, rice, potatoes, etc. Their demand falls with the availability of quality alternatives. The word inferior, in this case, does not mean substandard goods. It relates to the affordability of such goods. As income increases, consumer demand for such goods falls, because consumers might for example substitute rice for meat. Consequently, the consumers view these goods as inferior.
These are inferior goods whose negative effect when price decreases outweighs the positive substitution effect. As a result, a decrease in the price of these good causes a decrease in the quantity consumed while an increase in the price causes an increase in the consumption of the goods. The idea is that if you are very poor and the price a basic food item increases, but you still can’t afford the more expensive alternative food, then you end up buying more of the basic food item because it is the only thing you can afford. Since everyone does the same thing, it’s price keeps increasing. The is some evidence suggesting that Giffen good’s are possible in today’s economy but is still theoretically possible.
These are mostly goods of prestige, such as expensive cars and high-end watches. An increase in the price of these goods causes an increase in the amount consumed and vice versa. Therefore, an increase in the consumption of such goods is due to the perception that consuming more of such goods conveys a higher status.
Comparison charts for Normal and inferior goods
Point to note
Note how substitution effect and income effect affect normal and inferior goods
If the cross-price elasticity between two goods is negative, the two goods are classified as:
The correct answer is C.
The consumption of complements rises or falls together. For negative cross-price elasticity, an increase in the price of one good causes the demand for both to go down.
Reading 14, LOS 14c:
Distinguish between normal goods and inferior goods.