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Inferior goods are groups of goods whose demand falls when consumer income rises. And, in economics, the demand for goods has a negative income elasticity (<0).
Inferior good elasticity
We use income elasticity to categorize goods as inferior or normal goods. Income elasticity is a measure of the responsiveness of the demand quantity in response to changes in income. The mathematical formula is as follows:
Income elasticity of demand (IE) =% Change in demand quantity /% Change in income
Based on the sign of the elasticity value, we differentiate goods into two groups.
- Normal goods. Their elasticity is positive (IE> 0). When income rises, the demand quantity increases. But, when income decreases, their demand quantity increases.
- Inferior goods. Their elasticity is negative (IE <0). An increase in income decreases their demand. And, a decrease in income results in higher demand quantity.
Furthermore, of the normal goods, we divide them into two, based on the value of elasticity of goods, namely necessities and luxury goods.
Demand for luxury goods is elastic in income (IE> 1). If consumer income rises by 5%, the demand for them increases by more than 5%.
In contrast, necessities have an income elasticity of more than zero but less than one (0 <IE <1). In other words, their demand is inelastic in income. If income rises by 5%, their demand quantity is smaller than 5% (but not negative).
Furthermore, some inferior products may be elastic. In a sense, when consumer income increases by 5%, demand for them falls by more than 5%. And, some others are inelastic, and when income increases by 5%, demand decreases by less than 5%. However, at least, in textbooks, economists do not differentiate inferior products based on their income elasticity.
Normal and inferior goods examples
Normal items you can find in every day. Luxury goods are for some rich people. Necessities are for a large portion of the population.
Meanwhile, inferior goods are for most poor people. When their income rises, they will ask for higher quality goods.
Used cars are examples of inferior goods. Consumers prefer to them if their income is low.
But, if their income rises, their demand for used cars goes down. They switch to a new car because it becomes more affordable. So, in this income range, they consider used cars as inferior.
Cheap foods such as instant noodles and cassava are other examples of inferior goods. When income rises, individuals are unconsidered and buy more expensive, attractive, or nutritious foods.
You should note that the classification of goods as “normal” and “inferior” varies between individuals. It depends on their income level.
Certain items may be inferior goods for some income ranges and normal goods for other income ranges. For some consumers, hamburgers are inferior because when income increases, they can buy more steaks and fewer burgers.
How does falling prices affect inferior goods?
To explain price changes to demand inferior goods, recall the concept of price effects in economics. The price effect consists of two:
- Substitution effect
- Income effect
The substitution effect links the relative prices of two interrelated goods. The substitution effect is always negatively related. It always goes in the opposite direction with price changes. I mean, when the price of goods goes up, it reduces their demand. Because consumers turn to alternative products.
But, when product prices fall, demand will go up. Consumers move from substitute products to these products. Remember, I am assuming the price of substitute goods has not changed.
The income effect explains the effect of price changes on consumers’ real incomes. If prices fall, real consumer income rises. They can buy more items with the same amount of money.
In contrast, if prices rise, real income falls. The same money buys fewer items because prices go up.
Price effects on normal goods
Normal goods have a positive income effect. An increase in the nominal income of consumers increases the demand for them.
If prices fall, they increase the real income of consumers. Thus, lower prices also increase demand for normal goods.
Because the substitution effect is always negative, falling prices will increase demand for normal goods. As a result, for normal goods, the substitution effect and income effect are mutually reinforcing.
Normal goods demand rises when prices fall. Both the income effect and the substitution effect act to increase demand for them.
Price effects on inferior goods
Income and substitution effects also apply to inferior goods. But, both are in opposite directions.
When prices fall, the income effect for inferior goods is negative. Falling prices increase the real income of consumers, thereby reducing demand for them.
Because it is always negative, if the price of an inferior item goes down, demand will go down because consumers will be looking for alternatives.
When prices of inferior goods fall, demand is still positive but less elastic than before the increase. The income effect acts to reduce the quantity demanded (say decrease by 10 units). Whereas, the substitution effect increases the quantity demanded (say up 15 units).
The end result, falling prices still increase the quantity demanded (up by 5 units) because the substitution effect outweighs the income effect. However, because the negative income effect partially offsets the positive substitution effect of falling prices, the increase in demand is relatively small (less elastic than before).
Special case for inferior goods: Giffen goods
Why a special case? Because, in general, inferior goods, the substitution effect still dominates. So, when prices fall, demand for inferior goods is positive, although less elastic.
In contrast, for Giffen goods, the negative income effect from falling prices of goods is powerful and outweighs the positive substitution effect. Therefore, for Giffen goods, the quantity demanded actually falls when the price of inferior goods falls. That makes the demand curve tilt upward.
For example, if the price of Giffen goods falls, the income effect causes the quantity demanded to fall by 10 units. But, the substitution effect causes demand to rise by only 5 units. As a result, falling prices cause a decrease in demand of 5 units.
How do economic conditions affect the demand for inferior goods?
When the economy improves, people’s incomes increase. Employment is more available, and wages are also starting to rise. In this situation, the household will reduce the demand for inferior goods. They will replace it with more expensive and quality goods.
However, when economic conditions experience a recession, demand for inferior goods will increase. Recession worsens household income conditions. Employment is shrinking, and more unemployed workers are in the economy. When this happens, the household can only reach inferior goods than normal goods.
