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The wealth elasticity of demand, in microeconomics and macroeconomics, is the proportional change in the consumption of a good relative to a change in consumers' wealth (as distinct from changes in personal income). Measuring and accounting for the variability in this elasticity is a continuing problem in behavioral finance and consumer theory.
The wealth elasticity of consumption quantity for some good will determine the size of the expenditure shift due to unexpected changes in net personal wealth, ceteris paribus (i.e. the size of the so-called "wealth effect" for a given good). It is calculated as the ratio of the percent change in consumption to the percent change in wealth that caused it.
This is analogous to the definition of the income effect from the income elasticity of demand, or the substitution effect from the price elasticity. The measure of "wealth" is mostly taken to be total personal realizable wealth at market prices, liquid or not:
Some economists say that bonds are simply a loan to the government and that they are not considered (on the aggregate) to be part of net wealth. Generally, the wealth change is measured in real terms.
It may seem obvious that an unanticipated windfall will lead to greater consumption and that a fiscal loss will have the opposite effect. However, when the stock markets crashed in April 2000 (wiping out $2.1 trillion in nominal investor wealth) U.S. household consumption did not drop substantially.
Some researchers have tried to resolve this difficulty by redefining wealth as the 'stable underlying value' of assets, which doesn't change with asset values, although this raises other questions of consumer rationality.
Most researchers calculate the wealth effect in real terms, so a deflation in price levels will increase personal wealth on average (because the total wealth in society is positive, the difference between saving and debt is tangible assets, such as land). The increase in private real wealth may give rise to a wealth effect of increased consumption. The macroeconomic effect of this on employment is called the Pigou effect, but whether or not this acts as a significant brake on a deflationary spiral is controversial. Pigou's reasoning for a positive wealth elasticity was that richer people feel more secure in the future and hence save less from current income. (So wealth is not redistributed by the effect.)
The elasticity has important implications for monetary policy: Investments with a fixed yield (such as a bond paying coupons at 5%) will increase in net present value as interest rates fall. Since fixed-income bond-holders’ personal wealth (at market rates) has increased, this may stimulate expenditure in a wealth effect. Working the other way, central banks often need to guess the wealth elasticity for asset price changes that have already happened in order to adjust the interest rate. In particular, the extent to which house price increases affect the rest of the economy is a critical question.
A naïve assumption (or first approximation) linking the wealth and income elasticities of demand is:
However, this approach overlooks the fact that people typically treat income and capital differently. (Behavioural economics hypothesises different "mental accounts" for income and assets, and points to empirical studies showing that the marginal propensity to consume extra income is one, but is lower for windfall asset increases.)
Econometric research is ongoing to find good wealth elasticity parameters, especially in areas like house-price-related wealth effects. However, some patterns are widely believed to hold:
If 'leisure time' is a superior good the income effect will partially cancel itself out, since people will work less as their hourly pay goes up. A change in net wealth doesn't require economic labour to produce, and has a different impact on the labour market.
Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics focuses on the study of individual markets, sectors, or industries as opposed to the national economy as whole, which is studied in macroeconomics.
Macroeconomics is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and government spending to regulate an economy’s growth and stability. This includes regional, national, and global economies. According to a 2018 assessment by economists Emi Nakamura and Jón Steinsson, economic "evidence regarding the consequences of different macroeconomic policies is still highly imperfect and open to serious criticism."
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This aims to be a complete article list of economics topics:
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In economics, a luxury good is a good for which demand increases more than what is proportional as income rises, so that expenditures on the good become a greater proportion of overall spending.
Economic theories of intertemporal consumption seek to explain people's preferences in relation to consumption and saving over the course of their lives. The earliest work on the subject was by Irving Fisher and Roy Harrod, who described 'hump saving', hypothesizing that savings would be highest in the middle years of a person's life as they saved for retirement.
In economics, the Pigou effect is the stimulation of output and employment caused by increasing consumption due to a rise in real balances of wealth, particularly during deflation. The term was named after Arthur Cecil Pigou by Don Patinkin in 1948.
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This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.