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?

Answer 1

As the income elasticity of peanut butter is -0.7, and with an expected income drop of 15%, you should increase your purchase orders for peanut butter by 10.5% to meet the projected rise in demand.

Step-by-step explanation:

If you are the manager of a supermarket and know that the income elasticity of peanut butter is -0.7, and you expect incomes to drop by 15% next year, you should anticipate a decrease in the quantity demanded for peanut butter. Since the income elasticity of peanut butter is negative (inferior good), as income decreases, demand for peanut butter will increase.

Based on the formula for calculating the change in demand due to income elasticity:

Percentage Change in Quantity Demanded = Income Elasticity × Percentage Change in Income

In this case:

Percentage Change in Quantity Demanded = (-0.7) × (-15%) = 10.5%

Hence, you should adjust your purchase orders for peanut butter by increasing them to meet the expected 10.5% rise in quantity demanded due to the recession-caused drop in incomes.