Necessities are types of normal goods that their demand is inelastic in income. When consumer income changes, their demand quantity also changes but at a lower percentage than the change in income. For example, if consumer income rises from 5%, then demand will increase by less than 5%.
What is the income elasticity of necessities?
The income elasticity tells you how responsive the change in demand quantity is when the consumer’s income changes. We calculate it with the following formula:
Income elasticity of demand = % Change in demand quantity of a good /% Change in income
When the demand for an item is positively related to consumer income, we call it a normal good. It has a positive income elasticity. When income rises, the demand quantity also rises. In contrast, when income falls, the demand quantity also falls.
On the other side, if the demand for a good is inversely related to consumer income, we call it an inferior good. An increase in consumer income reduces demand. And when income falls, the demand quantity increases.
Next, there are two categories of normal goods: necessities and luxury goods. The difference between the two lies in their responsiveness to changes in consumer income.
Luxury goods have an income elasticity of more than 1. When consumer income rises by 5%, it increases the quantity of demand by more than 5%. And the opposite result applies when income falls. Thus, we can say the demand for luxury goods is elastic in income.
The opposite of luxury goods is necessities. Their income elasticity is more than zero elasticity but less than one. If consumer income rises by 5%, the demand quantity increases by less than 5%. Likewise, if income falls by 5%, the demand quantity drop by less than 5%. In this case, the demand for necessities is inelastic in income.
What are the examples of necessities?
Necessities cover products and services that consumers will buy regardless of changes in their income level. They don’t buy a lot when their income rises high, like during an economic expansion. And, they won’t drastically reduce demand as their income decreases during a recession.
Water, electricity, tobacco products, and haircuts are examples. Likewise, products such as toothbrushes and toilet paper are necessities. You will not buy a lot the two when your income rises or reduce purchases when your income falls.
However, what you categorize as “necessities” and “luxury” vary among individuals. It depends on your income level and where you live. Economic factors such as economic prosperity can also affect the definition of “necessities” by some people.
For example, when the 2009 crisis hit, 88% of Americans thought that cars were necessities. This percentage decreased compared to 2006 (91%). Likewise, 66% of them considered clothes dryers as a necessity in 2009, down from 83% in 2006. The recession made it difficult for some households to afford some necessities. That caused them to no longer classify some of the necessities as a luxury item.