Income Elasticity of Demand and Consumer Purchases Post-Covid

I came across this material on the blog ‘Sex, Drugs and Economics’ which discusses Bruce Wydick’s post on his blog ‘Across Two Worlds’. This is very useful for NCEA Level 3 and CIE AS Level Unit 2 both of which look at Income Elasticity of Demand.

Wydick looks at who is most likely to do well and who is likely to suffer in a post-covid environment. A typical recession is generally caused by supply-side factors (oil crisis years of 1973 – prices up by 400% – 1979 – prices up by 200%) or demand-side impact (loss of business confidence and consumer confidence). Covid-19 is very different as it is a complete shut-down of certain businesses and it forced people to stop buying things that they normal do. Wydick puts goods and services into two categories:

Snap-Back goods and services – things we couldn’t buy during the Level 4 lock-down period but were purchased when we went to Level 3. Pent up demand meant that purchases of these goods and service might have been higher than normal – buying less now means buying more later.

Gone Forever – as it states. Invariably this generally refers to services like air travel, tourism, haircuts, public transport and entertainment. When it becomes safe to have a haircut you still only get one haircut as the rest of your haircuts have disappeared and there is no catch-up spending like with snap-back goods.

These are the differences between goods with low versus high income elasticity. Income elasticity of demand measures the responsiveness of quantity demanded to changes in income. We can have different types of normal goods. If a 10% increase in income brought about a 10% increase in quantity demanded, we can say the income elasticity of demand is unitary. If EY>1 we classify the good as a luxury, and if EY<1, a necessity.

Income elasticity of demand will also affect the pattern of demand over time. For normal luxury goods, whose income elasticity of demand exceeds +1, as incomes rise, the proportion of a consumer’s income spent on that product will go up. For normal necessities (income elasticity of demand is positive but less than 1 and for inferior goods (where the income elasticity of demand is negative) – then as income rises, the share or proportion of their budget on these products will fall. Wydick puts the different types of purchases in a simple 2 x 2 matrix“Snap-Back” vs. “Gone Forever” and High vs. Low income elasticity. 

It then becomes easy to see which industries are in the most trouble in 2020.  So, when goods and services are both “gone forever” and have a high income elasticity, we can expect the impact of the coronavirus pandemic to be most severe. Wydick identifies air travel, tourism, sporting events, hospitality, and transport (but not public transport). Everything else either snaps back and experiences some catch-up spending, or isn’t as affected by lower incomes. Goods that have a high income elasticity means that when you lose your job during the recession, you and others like you are even less likely to buy these things. For New Zealand the decline of the tourism industry is a significant hit to GDP and employment in this sector.

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