Questions: Suppose that Good Z has an income elasticity of -1.25. If income falls then... a. Supply Expands b. Demand Expands c. Demand Contracts d. Supply Contracts

The answer is c: Demand Contracts.

Explanation:

1. Income Elasticity of Demand: This measures how the quantity demanded of a good responds to a change in consumer income. It is calculated as the percentage change in quantity demanded divided by the percentage change in income.

2. Negative Income Elasticity: An income elasticity of -1.25 indicates that Good $Z$ is an inferior good. For inferior goods, demand decreases as income increases, and conversely, demand increases as income decreases.

3. Income Falls: Given that the income elasticity is negative, a fall in income will lead to a decrease in the demand for Good $Z$. This is because, for inferior goods, demand contracts when income falls.

Explanation of Options:

• a. Supply Expands: This option is incorrect because the question pertains to demand, not supply. Income elasticity affects demand, not supply.
• b. Demand Expands: This option is incorrect because a negative income elasticity means that demand contracts when income falls.
• c. Demand Contracts: This is the correct answer because a negative income elasticity indicates that demand decreases when income falls.
• d. Supply Contracts: This option is incorrect because the question is about demand changes, not supply changes.

In summary, with an income elasticity of -1.25, a fall in income will lead to a contraction in the demand for Good $Z$.