What Is an Inferior Good?
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Summary:
An inferior good is a term used in economics for goods whose demand falls when income increases. Contrary to normal goods or luxury goods, demand for inferior goods falls when people make more money. Understanding inferior goods is crucial to understanding consumer behavior in economics.
Every day in our lives, we make choices about what we buy. Are we going to go to Dunkin’ Donuts for a cheap regular coffee, or are we going to splurge at Starbucks for a Caramel Frappuccino? Typically our spending habits are governed by our income and the money in our pocket. If we have a little extra money coming in, then we might opt for that Caramel Frappuccino. Likewise, if times are tight that month for whatever reason, we might stick to cheap Dunkin’ coffee with a religious fervor. Like most consumer behavior, these types of choices are monitored and calculated by the rules of modern economics.
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What is an inferior good?
An inferior good is a term used in economics to explain the behavior of consumers. Effectively, when incomes rise, consumers’ desire to purchase inferior goods will drop. This is due to the consumer having more variety of choices as they have more money.
A classic example of this can be illustrated with a Dunkin’ coffee and a Starbucks coffee. They are both coffee, but Starbucks is generally considered a better quality of coffee, and the price reflects this. Although a consumer might require coffee every day to get their morning started, their choice of a Starbucks coffee over a Dunkin’ coffee is dictated by their income. If times are good and the economy is growing, consumers might start to opt for Starbucks coffee more frequently. In this scenario, Dunkin’ Donuts’ cheaper coffee can be classified as an inferior good in economic terms.
Income elasticity of demand
To understand inferior goods’ role in the general background of modern economics, it’s important to comprehend the fundamental driver behind it: the income elasticity of consumer demand. The income elasticity of demand is the measure of how demand changes with respect to income.
There are several types of goods that pertain to the income elasticity of demand. These include inferior goods, normal goods, luxury goods, and inelastic goods.
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Inferior goods vs. normal goods
Another term used in economics to define consumer behavior is normal good, or necessary good. Contrary to inferior goods, demand for normal goods rises when incomes increase. An example of a normal good is organic coffee. If a consumer is low on income, they might stick to Folgers. However, if a consumer’s income rises, they might only buy organic coffee. This works as the direct opposite of inferior goods, which you can see in the graph below.
As you can see, the X- and Y-axis of the graph represent income and demand. The downward trajectory of the inferior goods in the graph shows how as income falls, the demand for inferior goods rises. The upward trajectory of the graph shows that when income rises, the demand for normal goods increases.
Inferior goods vs. luxury goods
Luxury goods are a separate category from inferior goods and normal goods. Luxury goods are goods that are not considered necessary to survive. People buy luxury goods not only when their incomes rise but when they have a good amount of wealth and assets to spend. Examples of luxury goods are Rolex watches, Lamborghinis, and fine art.
Similar to normal goods, the demand for luxury goods rises as income rises. But the money spent on these luxury goods is an even higher proportion of overall spending than that spent on normal goods.
Inferior goods vs. inelastic goods
Inelastic goods are generally goods that are essential to survival. They are deemed “inelastic” because their demand does not change regardless of income. Furthermore, it’s often difficult to stockpile inelastic goods. Examples of inelastic goods are utilities or prescription drugs. Regardless of your income, in the winter, you need electricity or gas to heat your home. Likewise, if you have a heart defect, regardless of income, you need that heart medication to survive.
Inelastic goods are considered the least elastic goods, meaning they do not change with income level. This runs contrary to luxury goods, which are the most elastic goods. This means they change the most with income level.
Examples of inferior goods
Now that we understand how the different types of goods are measured in modern economics, what exactly constitutes inferior goods in the life of your average human being? Here are some examples.
Transportation
Affordable transportation is a classic example of an inferior good that most people will use at some point in their lives. Let’s say you graduate college and get a job with an average income. At this point, because you are just starting out, you need to take a bus and a subway to get to work. However, once your income rises, you might opt to buy a car and use that instead. Thus, your use of public transportation such as buses and subways will fall, whereas your car use will increase.
Travel
Where you sleep and eat, either in your normal life or when you travel, could be defined as an inferior good. For instance, say that you like visiting the mountains in Yosemite National Park. When you first go there, you might opt to stay in a tent on a camping ground. However, as you begin to build more income, you might opt to stay in a hotel or a hybrid “glamping” scenario.
Eating and Drinking
Food and drink are other common examples of goods that can be inferior. For instance, when people are in college and have little money to spend, they often opt for cheap beer, such as Keystone Light, and ramen noodles. However, once they graduate and have a job for a few years, they might opt to buy nice bottles of wine from Mendoza, Argentina and more expensive meals. The cheap beers are considered inferior goods in this scenario, as demand falls when people have more money to spend.
Brands
An easy example of inferior goods can be seen in people’s choice of brands when they shop. Almost every grocery store in the US will have its own generic brand. These are usually based on other products from name brands that have become popular. For example, if you love Lucky Charms but have limited money, you might opt for the generic imitation that the store provides. Once your income rises, you might drop the generic Charms for the full-on Lucky Charms that you always craved.
GDP growth and inferior goods
A good way to look at inferior goods from a macroeconomic viewpoint is to look at their correlation to GDP growth. When GDP expands, demand for inferior goods will fall, as people’s incomes generally rise. When GDP contracts, demand for inferior goods will rise as people’s incomes shrink. Therefore, in a recessionary scenario, companies that focus on inferior goods tend to do well.
2008 financial crisis and dollar stores
If you have lived in the United States for any period of time, you have likely witnessed the quintessential purveyor of “inferior goods.” These are the dollar stores, of course. Dollar stores are stores that sell mainly inferior goods for generally a dollar or less. Among the most popular stores are Dollar Tree and Family Dollar.
In 2008, the United States underwent a systemic shock to its economy due to the subprime mortgage/financial crisis. A brutal recession immediately followed. However, because incomes declined due to the crisis and subsequent recession, sales for these two dollar stores actually increased.
For the three months ending in February 2009, at Family Dollar, sales actually increased 6.4% versus the same time the previous year in 2008. A similar scenario happened with Dollar Tree, which at the time had more than 3,600 U.S. stores. According to the New York Times, “Timothy J. Reid, vice president of investor relations for Dollar Tree, said the company had a 3.7 % increase in the number of transactions in 2008 compared with the previous year.”
This runs contrary to what most people think about economics. You might assume that all businesses will do poorly in a bad economy. This is not the case for businesses that specialize in inferior goods, such as dollar stores. In times of contraction, they will do well.
Pro Tip
If you are convinced that there might be a recession or some other unforeseen event that will cause incomes to go down, then investing in stocks of companies like Dollar Tree that focus on inferior goods could be a smart decision.
FAQ
What are superior goods?
Superior goods are goods like normal goods and luxury goods. The demand for them increases as incomes rise.
What is an inferior good meaning?
An inferior good is a good whose demand falls as income rises.
Is fast food an inferior good?
Yes, fast food or cheap food, in general, is considered an inferior good.
What are examples of normal and inferior goods?
Using coffee as an example, a normal good would be a more expensive Starbucks Frappuccino, and an inferior good would be a cheap black coffee from Dunkin’ Donuts.
Key takeaways
- Inferior goods are goods whose demand falls as income rises.
- Examples of inferior goods can be cheap coffee or items at a dollar store.
- Inferior goods are contrary to luxury goods or normal goods, as those goods’ demand rises with an increase in income.
- Food, drinks, and travel are economic subsections that will all have inferior goods.
- When GDP growth rises, demand for inferior goods will fall.
- Likewise, when GDP contracts, demand for inferior goods will rise. A perfect example is the sales increase at dollar stores after the 2008 financial crisis.
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