9/30/2009

A Life Lesson in Income Elasticity

Income elasticity has always interested me because of its true to life applications. It’s very remarkable how one can actually see how their demand curves shift to the left and right as our income fluctuates. When I lived at home and my parents subsidized a great deal of my expenses, normal goods made up a good deal of my consumption. This is because the quantity demanded for normal goods increases as income increases. After high school, I left to Mexico on a 2-year mission for the LDS Church. We received 200 pesos a week (roughly $20) for food and living expenses. That’s when inferior goods such as rice, beans, and tortillas became a normal part of my diet. When I returned home, my parents helped me get on my feet and I had somewhat of a cross between normal and inferior goods at my disposal. Now, I am a married college student with a baby girl and inferior goods seem to have raided my house and built a permanent establishment in most locations.

The article I found says that “[in] many cases, income elasticity has a direct impact on the dietary habits of households.” That hit home for me because as I look back on the past, it’s the part of my life that has been affected most. Two of the inferior goods it presents as inferior goods are on my table with me as I’m writing this (Ramen and store brand food). Knowing the effects of income elasticity can help people and companies forecast demand of goods depending on current economic conditions and other factors. Right now, for example, in our own economic state, I think it would be a good guess in saying that the quantity demanded of inferior goods has gone up and inversely for normal goods.

http://mbaecon.wikispaces.com/income+elasticity

7 comments:

Jayden said...

Adam, I think you’re right on in your analysis of the quantity demanded for normal and inferior goods. I also liked how your source article addressed luxury goods. Here’s my “life lesson in income elasticity” regarding a luxury good (at least I consider it a luxury good). Last summer, I visited relatives in Hawaii and paid an exorbitant amount to do it. This summer, demand for the flights had decreased so much that airlines were slashing prices to fill seats. The decreased demand and resulting price cuts enabled me to visit my relatives for less than half the price I paid the previous year. The income elasticity of demand for luxury goods is indeed high.

Brendan said...

I like how you related normal and inferior goods to your personal life. My family always had inferior goods in the cupboards. When I got out on my own, I always tried buying the normal foods (especially cereals) regardless of income elasticity because I never knew what it tasted like. So to me, inferior goods are normal and normal goods are luxury. The so called "big-ticket" items mentioned in the article is something I have never gotten a taste of. Hopefully my senses of inferior, normal, and luxury goods gets straightened out over time.

Jayden said...

Ha ha, Brendan, I can relate to your post 100% - right down to the cereal! My Hawaii trips are my token "big-ticket" items. ;-)

Dr. Tufte said...

You should all go and read the comment I just left on the previous post about the elasticity of healthcare, and how no one talks about its income elasticity.

I think this is a good post Adam. I would add - to relate back to that last post - that I bet Adam could see the same pattern of spending in his healthcare as his income fluctuated.

Jayden's point is excellent, although more complex that it is presented here (the reason is that the cheap flights make you buy more because of price elasticity, but the cheapness has a second effect because it makes you feel richer).

I laughed at Brendan's comment. For me, when I got my first "grown-up" job, the luxury that I wanted was premium cable channels (because I never had these when I was growing up).

Daniel said...

Adam mentioned some income inelastic goods and which caused me to wonder the following: for those fortunate to have money to invest during these uncertain times, where should investors move their money? The “Oracle of Omaha,” Warren Buffett, has long invested in companies that produce income inelastic goods. Buffett’s knack for identifying and investing in companies which produce inelastic and “recession proof” products have made him legendary. For instance, Buffett companies own large stakes in the Coca-Cola Company, Sees Candies, a leased furniture company, and now Buffett has his eyes on companies producing another inelastic good – lithium.

Lithium is the lightest medal known to man and is used to develop batteries for hybrid electric vehicles. Lithium’s growth has only slightly been affected by the recession and features the classic Buffett investment trait – its income elasticity track record is predictable and strong. So for those with a little extra money to invest – consider Buffett’s track record for investing in companies producing income inelastic goods. For more on Buffett’s interest in lithium, please see the article in the link below: http://www.commodityonline.com/news/Why-Warren-Buffet-is-investing-in-lithium-21124-3-1.html

Lucid Capital said...
This comment has been removed by the author.
skylar said...

Nice investing advice Daniel. You might need to put an disclaimer on that one. While I was reading this article I thought about a few goods that I have stocked up on and most of those are the cheap family basics like Cereal. When I was growing up Cereal seemed to be a normal good, but with the coupons, supply, and sales it has become an inferior good in my household. I love Cereal!