Inferior good

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Good Y is a normal good since the amount purchased increases from Y1 to Y2 as the budget constraint shifts from BC1 to the higher income BC2. Good X is an inferior good since the amount bought decreases from X1 to X2 as income increases. Inferior good.png
Good Y is a normal good since the amount purchased increases from Y1 to Y2 as the budget constraint shifts from BC1 to the higher income BC2. Good X is an inferior good since the amount bought decreases from X1 to X2 as income increases.

In economics, an inferior good is a good whose demand decreases when consumer income rises (or demand increases when consumer income decreases), unlike normal goods, for which the opposite is observed. Inferiority, in this sense, is an observable fact relating to affordability rather than a statement about the quality of the good. There are many examples of inferior goods, including cheap cars, public transit options, payday lending, and inexpensive food. The shift in consumer demand for an inferior good can be explained by two natural economic phenomena: the substitution effect and the income effect.

Contents

Description

In economics, inferior good is a good whose demand decreases when consumer income rises (or demand increases when consumer income decreases). [1] [2] This behavior is unlike the supply and demand behavior of normal goods, for which the opposite is observed; [3] normal goods are those goods for which the demand rises as consumer income rises. [2] [4]

Inferiority, in this sense, is an observable fact relating to affordability rather than a statement about the quality of the good. As a rule, these goods are affordable and adequately fulfill their purpose, but as more costly substitutes that offer more pleasure (or at least variety) become available, the use of the inferior goods diminishes. Direct relations can thus be drawn from inferior goods to socio-economic class. Those with constricted incomes tend to prefer inferior goods for the reason of the aforementioned observable inferiority. [5]

Depending on consumer or market indifference curves, the amount of a good bought can either increase, decrease, or stay the same when income increases. [2]

Examples

There are many examples of inferior goods. A number of economists have suggested that shopping at large discount chains such as Walmart and rent-to-own establishments vastly represent a large percentage of goods referred to as "inferior". Cheaper cars are examples of the inferior goods. Consumers will generally prefer cheaper cars when their income is constricted. As a consumer's income increases, the demand for the cheap cars will decrease, while demand for costly cars will increase, so cheap cars are inferior goods.

Inter-city bus service is also an example of an inferior good. This form of transportation is cheaper than air or rail travel, but is more time-consuming. When money is constricted, traveling by bus becomes more acceptable, but when money is more abundant than time, more rapid transport is preferred. In some countries with less developed or poorly maintained railways this is reversed: trains are slower and cheaper than buses, so rail travel is an inferior good.

Certain financial services, including payday lending, are inferior goods. Such financial services are generally marketed to persons with low incomes. People with middle or higher incomes can typically use credit cards that have better terms of payment or bank loans for higher volumes and much lower rates of interest. [6]

Inexpensive foods like instant noodles, bologna, pizza, hamburger, mass-market beer, frozen dinners, and canned goods are additional examples of inferior goods. As incomes rise, one tends to purchase more expensive, appealing or nutritious foods. Likewise, goods and services used by poor people for which richer people have alternatives exemplify inferior goods. As a rule, used and obsolete goods (but not antiques) marketed to persons of low income as closeouts are inferior goods at the time even if they had earlier been normal goods or even luxury goods.

Others are very inconsistent across geographic regions or cultures. The potato, for example, generally conforms to the demand function of an inferior good in the Andean region where the crop originated. People of higher incomes and/or those who have migrated to coastal areas are more likely to prefer other staples such as rice or wheat products as they can afford them. However, in several countries of Asia, such as Bangladesh, potatoes are not an inferior good, but rather a relatively expensive source of calories and a high-prestige food, especially when eaten in the form of French fries by urban elites. [7]

Income and substitution effects

An item such as non-branded grocery products are common inferior goods. There is no set criteria of what constitutes an inferior good, but economists refer to an inferior good as any item preferred less when disposable consumer income increases. Home brand beer nuts.jpg
An item such as non-branded grocery products are common inferior goods. There is no set criteria of what constitutes an inferior good, but economists refer to an inferior good as any item preferred less when disposable consumer income increases.

The shift in consumer demand for an inferior good can be explained by two natural economic phenomena: The substitution effect and the income effect. These effects describe and validate the movement of the demand curve in (independent) response to increasing income and relative cost of other goods. [8]

Income effect

The income effect describes the relationship between an increase in real income and demand for a good. Inferior goods experience negative income effect, where its consumption decreases when a consumer's income increases. [9] The increase in real income means consumers can afford a bundle of goods that give them higher utility. Inferior goods are unlikely to provide the latter, thus why its consumption decreases.

Substitution effect

The substitution effect occurs due to a change in relative prices between two or more goods. Compared to normal goods, a price decrease (or increase) would actually decrease (or increase) the consumption of an inferior good. This is only possible if negative income effect is strong or large enough to outweigh the substitution effect. [9]

Overall change in demand for an inferior good

The income and substitution effects work in opposite directions for an inferior good. When an inferior good's price decreases, the income effect reduces the quantity consumed, whilst the substitution effect increases the amount consumed. In practice, it has been observed that the substitution effect is usually larger than the income effect due to the small amount of gross income allocated by consumers on any given good, and thus the change in demand is usually insignificant in comparison to the substitution effect. [9]

Giffen goods

A special type of inferior good may exist known as the Giffen good, which would disobey the "law of demand". Quite simply, when the price of a Giffen good increases, the demand for that good increases. This would have to be a particular good that is such a large proportion of a person or market's consumption that the income effect of a price increase would produce, effectively, more demand. The observed demand curve would slope upward, indicating positive elasticity. [10]

Giffen goods were first noted by Sir Robert Giffen. It is usual to attribute Giffen's observation to the fact that in Ireland during the 19th century there was a rise in the price of potatoes. The explanation follows that poor people were forced to reduce their consumption of meat and expensive items such as eggs. Potatoes, still being the cheapest food, meant that poor people started consuming more even though its price was rising. This phenomenon is often described as "Giffen's Paradox". However, it has been noticed[ by whom? ] that Giffen did not use potatoes as an example of Giffen goods. [11] Moreover, potatoes were not Giffen Goods during the Great Famine in Ireland. [12] Alfred Marshall's explanation of Giffen's Paradox was presented in terms of bread. [13]

See also

Related Research Articles

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In microeconomics, supply and demand is an economic model of price determination in a market. It postulates that, holding all else equal, in a competitive market, the unit price for a particular good, or other traded item such as labor or current financial assets, will vary until it settles at a point where the quantity demanded will equal the quantity supplied, resulting in an economic equilibrium for price and quantity transacted. The concept of supply and demand forms the theoretical basis of modern economics.

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The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption, by maximizing utility subject to a consumer budget constraint. Factors influencing consumers' evaluation of the utility of goods include: income level, cultural factors, product information and physio-psychological factors.

<span class="mw-page-title-main">Giffen good</span> Product that people consume more of as the price rises

In economics and consumer theory, a Giffen good is a product that people consume more of as the price rises and vice versa—violating the basic law of demand in microeconomics. For any other sort of good, as the price of the good rises, the substitution effect makes consumers purchase less of it, and more of substitute goods; for most goods, the income effect reinforces this decline in demand for the good. But a Giffen good is so strongly an inferior good in the minds of consumers that this contrary income effect more than offsets the substitution effect, and the net effect of the good's price rise is to increase demand for it. This phenomenon is known as the Giffen paradox. A Giffen good is considered to be the opposite of an ordinary good.

<span class="mw-page-title-main">Normal good</span> Good that increases in demand when incomes rise

In economics, a normal good is a type of a good which experiences an increase in demand due to an increase in income, unlike inferior goods, for which the opposite is observed. When there is an increase in a person's income, for example due to a wage rise, a good for which the demand rises due to the wage increase, is referred as a normal good. Conversely, the demand for normal goods declines when the income decreases, for example due to a wage decrease or layoffs.

<span class="mw-page-title-main">Veblen good</span> Luxury good for which the demand increases as the price increases

A Veblen good is a type of luxury good, named after American economist Thorstein Veblen, for which the demand increases as the price increases, in apparent contradiction of the law of demand, resulting in an upward-sloping demand curve. The higher prices of Veblen goods may make them desirable as a status symbol in the practices of conspicuous consumption and conspicuous leisure. A product may be a Veblen good because it is a positional good, something few others can own.

<span class="mw-page-title-main">Substitute good</span> Economics concept of goods considered interchangeable

In microeconomics, two goods are substitutes if the products could be used for the same purpose by the consumers. That is, a consumer perceives both goods as similar or comparable, so that having more of one good causes the consumer to desire less of the other good. Contrary to complementary goods and independent goods, substitute goods may replace each other in use due to changing economic conditions. An example of substitute goods is Coca-Cola and Pepsi; the interchangeable aspect of these goods is due to the similarity of the purpose they serve, i.e fulfilling customers' desire for a soft drink. These types of substitutes can be referred to as close substitutes.

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<span class="mw-page-title-main">Law of demand</span> Fundamental principle in microeconomics

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<span class="mw-page-title-main">Complementary good</span> Concept in economics

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<span class="mw-page-title-main">Luxury goods</span> Good for which demand increases more than what is proportional as income rises

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In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given time. The relationship between price and quantity demand is also called the demand curve. Demand for a specific item is a function of an item's perceived necessity, price, perceived quality, convenience, available alternatives, purchasers' disposable income and tastes, and many other options.

An ordinary good is a microeconomic concept used in consumer theory. It is defined as a good which creates an increase in quantity demanded when the price for the good drops or conversely a decrease in quantity demanded if the price for the good increases, ceteris paribus. It is the opposite of a Giffen good.

References

  1. ↑ Mankiw, N. Gregory, Principles of Economics, South-Western Cengage Learning, 2012, p.70
  2. 1 2 3 Varian, Hal R. (2014). Intermediate microeconomics : a modern approach (Ninth ed.). New York: W. W. Norton. p. 96. ISBN   9780393919677. OCLC   879663971.
  3. ↑ "Economics A–Z: Inferior goods". The Economist. Retrieved 17 August 2016.
  4. ↑ O'Sullivan, Arthur; Sheffrin, Steven M. (2003), Economics: Principles in Action, Upper Saddle River, New Jersey 07458: Pearson Prentice Hall, p. 87, ISBN   0-13-063085-3 {{citation}}: CS1 maint: location (link)
  5. ↑ Kenton, Will. "Inferior Goods Definition". Investopedia. Retrieved 2021-04-23.
  6. ↑ "Payday Lending in America". The Pew Charitable Trusts. 18 July 2012. Archived from the original on 23 April 2016. Retrieved 28 July 2015.
  7. ↑ Scott, G.J.; Bouis, H.E., "Sustainability of Potato Consumption in Developing Countries: The Case of Bangladesh", Program Report 1995–1996, International Potato Center, archived from the original on 8 April 2010{{citation}}: CS1 maint: unfit URL (link)
  8. ↑ "Substitution Effect and Income Effect: Definitions and Implications - Don't Quit Your Day Job..." DQYDJ – Don't Quit Your Day Job... 2010-04-23. Retrieved 2021-04-23.
  9. 1 2 3 J.Singh (2014-06-17). "Price Demand Relationship: Normal, Inferior and Giffen Goods". Economics Discussion. Retrieved 2021-04-23.
  10. ↑ Varian, Hal R. (2014). Intermediate microeconomics : a modern approach (Ninth ed.). New York: W. W. Norton. p. 104. ISBN   9780393919677. OCLC   879663971.
  11. ↑ Stigler, George J. (1947). "Notes on the History of the Giffen Paradox". Journal of Political Economy. 55 (2): 152–156. doi:10.1086/256487. ISSN   0022-3808. JSTOR   1825304. S2CID   153443575.
  12. ↑ Dwyer, Gerald P.; Lindsay, Cotton M. (1984). "Robert Giffen and the Irish Potato". The American Economic Review. 74 (1): 188–192. ISSN   0002-8282. JSTOR   1803318.
  13. ↑ Marshall, Alfred (1949). Principles of Economics. New York: Macmillan. p. 132.
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