Understanding Inferior Goods & how they impact the economy

Inferior goods possess distinct characteristics that set them apart from other types of economic goods. The primary characteristic is the negative income elasticity of demand that characterizes them. As incomes increase, demand for these goods decreases.

Another characteristic of inferior goods is their relatively low price compared to other goods in the market. They are often priced lower to appeal to price-sensitive consumers. This pricing strategy enables businesses to attract a specific consumer segment that prioritizes affordability over quality.

Furthermore, inferior goods are often considered substitutes for higher-quality alternatives. Consumers may initially opt for lower-quality goods due to budget constraints or other factors, but as their incomes increase, they are more likely to switch to superior alternatives.

Inferior Goods vs. Normal Goods

Normal goods are products for which demand increases as A consumer’s purchasing power grows. As individuals or households experience higher income, they can afford to purchase more of these goods, leading to an upward shift in demand. Normal goods typically have positive income elasticity i.e., their income elasticity is greater than zero while the opposite is true for inferior goods.

The overall impact on the economy extends beyond individual consumer behavior, as incomes rise and consumers shift away from inferior goods, industries producing these goods may experience a decline in demand.

This shift in demand can lead to changes in employment and production levels within these industries. As consumers opt for higher-quality alternatives, companies producing lower-quality goods may need to adapt their operations or diversify their offerings to remain competitive.

The Engel Curve

The Engel curve is a graphical representation of the relationship between income and the quantity of a good consumed. It offers valuable insights into the income elasticity of demand for a specific product. By plotting different income levels on the x-axis and the corresponding quantity of the good consumed on the y-axis, a unique Engel curve can be generated for each product.

As can be seen in the graph above, the same good may be considered a normal good at lower income levels, but an inferior good at higher income levels. In other words, if a consumer has little money available (less than $40 per week in the graph) any increase in income will lead to more demand for economy burgers i.e., they are a normal good.

However, at an income over $40 per week, the consumer demand fewer economy burgers, as depicted by the backward sloping Engel curve. At these higher income levels, superior food products like premium burgers will start to be substituted, meaning that economy burgers are now an inferior good.

Examples of Inferior Goods

• Generic Food Products – Basic cereals, rice, or pasta, economy burgers etc. are often considered inferior. When consumers face tight budgets, they may opt for these lower-cost alternatives. However, as their incomes increase, the demand for higher-quality branded products is likely to rise.
• Used Cars – In the automobile market, used cars are commonly regarded as inferior goods. As consumers have limited financial resources, they may choose to purchase pre-owned vehicles. However, with an increase in income, the demand for new and more luxurious cars typically rises.
• Public Transportation – When incomes are lower, individuals may rely on these affordable options for commuting. But as their financial situations improve, they may prefer the convenience and comfort of private transportation like cars.
• Low-Quality Clothing – In the apparel industry, when money is tight, consumers may opt for budget-friendly clothing options. Yet, as they earn more, they may gravitate toward higher-quality and more fashionable clothing items.
• Fast Food – Fast food is another prime example of an inferior good. As people experience financial constraints, they may turn to fast food as a quick and inexpensive meal option. However, with higher income levels, they are likely to choose healthier and more upscale dining alternatives.

Giffen Goods

Now that we have a solid understanding of inferior goods and normal goods, it's worth mentioning Giffen goods. A Giffen good is a peculiar type of inferior good that defies typical demand behavior, because an increase in price actually leads to a rise in demand. This happens despite the reduced purchasing power of any given income when prices rise.

This seemingly paradoxical phenomenon occurs when the good in question represents a substantial portion of a consumer's budget, and its price increase puts a strain on their overall purchasing power. Consequently, the consumer may cut back on other goods and, in an attempt to compensate for the higher cost, end up buying more of the Giffen good.

For more information on this, see my main article about Giffen Goods

Sources:

• MIT - Normal and Inferior Goods (PDF)

Related Pages:

• Normal Goods
• Complementary Goods & Substitute Goods
• Merit Goods & Demerit Goods
• Veblen Goods
• The Income Effect
• The Substitution Effect
• Consumer Behavior

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