Normal goods are groups of products whose demand increases when consumer incomes rise. Conversely, when consumer incomes fall, demand for them also falls.
Various items of your daily needs, such as soap, tea, clothes, coffee, are examples of normal products. But, remember. What you categorize as “normal” is not the same as other people. It depends on your income level.
For poor individuals or residents in poor countries, increased income can lead to higher consumption of noodles or rice. Both are in the category of normal products.
Then, when their income increases, demand for noodles and rice falls. They buy more meat and seafood as part of daily food. Therefore, in this income range, noodles and rice are inferior products.
The concept of normal goods in the economy
In economics, normal goods have a positive income elasticity. That means, their demand has a positive relationship with consumer income. An increase in consumer income increases their demand for goods. And in contrast, a decrease in income reduces their demand.
Let’s review briefly about income elasticity.
Income elasticity concept is essential for you when you want to understand how changes in purchasing power affect changes in consumption patterns. It measures how responsive the demand for goods changes when consumer income changes. You can calculate it using the following formula:
Income elasticity of demand (IE) =% Change in demand quantity /% Change in income
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Based on their elasticity value, you can categorize items into two groups:
- Normal goods where the income elasticity is more than 0 (IE > 0). That means, when income rises, demand quantity will increase. And, the opposite result applies when income decreases.
- Inferior goods, where the income elasticity is less than zero (IE <0). Income has a negative relationship with the demand quantity. That means, when income rises, demand actually goes down.
In some textbooks, you can find several writers categorizing them into three items: necessities, luxury goods, and inferior products. Some of them sometimes synonymize normal goods as necessities.
In this article, I group them into two based on signs in their elasticity values: positive and negative. Normal product have a positive income elasticity. That’s different from inferior goods that have a negative income elasticity.
Then, the types of normal products consist of two groups of goods: necessities and luxury products. Necessities and luxury products have a positive demand elasticity. However, the two are different in terms of responsiveness to changes in income. Luxury products are relatively more elastic than necessities.
Necessities have an income elasticity of more than zero but less than one (0 <IE <1). Meanwhile, luxury goods have more than one income elasticity (IE> 1).
Necessities. This group of goods is relatively less responsive to changes in consumer income. When consumer income increases, the demand for these goods increases but at a lower percentage. If consumer income rises by 10%, then their demand increases by less than 10%.
Luxury goods. Their demand is relatively responsive to changes in consumer income. When consumer income rises (for example, 10%), demand for luxury goods increases higher than the percentage increase in income (for example, more than 10%).
Why is that? The increase in luxury goods represents an increase in the utility consumers get. So, the more expensive the goods, the higher the utility consumers feel.
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Inferior goods. This type of item has a negative (less than zero) income elasticity. This means that the demand for inferior goods falls when consumer income rises. And the opposite, when consumer income falls, demand for them will increase. Examples are flip flops, cassava, and so forth.
How are items considered as normal goods?
Most of the items around you are normal products . However, there are no standard criteria for classifying goods as normal or not.
Their grouping varies between individuals and the economy. What you call a necessity item, maybe a luxury item for others. Such classification variations occur because of differences in income levels between individuals.
Motorcycles, for example, could be a necessity for upper-income individuals. On the contrary, it can be a luxury item for needy individuals.
Likewise, pizza may be a normal item for most urban communities. Still, it can be a luxury item for rural communities.
Why do you need to know this term?
Classifying normal products as luxury products and necessities is important in an economy. It helps in making economic policy. The luxury tax is often higher than the tax on necessities. However, such discrimination does not result in the maximization of welfare.
Furthermore, such classifications also help the company. Calculating elasticity helps them to predict sales during an economic expansion that results in an increase in income, or during an economic recession that results in a decrease in income.
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