Engel's law

Engel's law - as the average income per one member of the household increases, not only the general demand increases, but also its structure changes. These changes are expressed by reducing the percentage share of all expenditure on food and other lower-order goods, and increasing expenditures on higher-order goods.

The name of this economic right comes from the name of the German economist Ernest Engl. The researcher published a work titled Die Productions - und Consumptionsverhaeltnisse des Koenigsreichs Sachsen in 1857, in which he included an analysis of the structure of household expenditure depending on the income earned. He is also the creator of the Engel's curve, which is a graphical depiction of the relationship between income earned by consumers and the amount of goods consumed by them. Ernest Engel was one of the largest statistics organizers in Germany. He defined statistics as a science that is able to present the general state. On the one hand, he regarded her as an independent field of science, on the other he claimed that it is only a method aimed at serving and helping all other sciences. He hoped that the statistics would be applicable in all administrative branches. Engel was also one of the founders of the International Statistical Congress.

II Engel's Law

Engel's Second Law - expenditures for luxury goods or savings appear only when the household reaches a high income, which exceeds all basic needs. Willingness and propensity to purchase luxury goods only appears when the rational costs of satisfying basic needs do not exceed 80 percent of all income earned by the consumer, the remaining 20 percent of income is the so-called fund of free decisions.

Division of goods

• Higher goods - the increase in demand is related to the increase in household income. They are usually permanent items of consumption, such as electronic equipment, furniture, refrigerators or cars. These goods are characterized by a factor of income elasticity of demand greater than 1.
• Lower-order goods (basic) - all kinds of food products, the purchase of which is necessary for every human being. The demand for it decreases with the increase in income, or grows less than proportionally in relation to income. Lower-order goods are characterized by a negative income elasticity of demand.

Engel curves

In his research, Ernest Engel noticed the relationship between income growth and an increase in demand for basic goods and higher-order goods. These dependencies can be perfectly illustrated using Engel curves. It is clear from them that the increase in income for both these goods is the same, but for basic goods, the increase in purchases decreases, and for higher goods, the increase in purchases increases. Therefore, it can be concluded that with the increase in income, the consumer is willing to spend a relatively larger amount of money for higher-order goods, while less spending on basic goods. Consumers may react differently to changing the level of income, both those that constitute their main source of income and the other, constituting a smaller part. The change in regular income often after some time results in a change in the structure of purchases made and the level and lifestyle of the consumer. Changes in other income may lengthen or shorten the period of these changes depending on favorable or unfavorable factors.

Engel's law and the standard of living of society

Engel's law applies only to middle-income families and is not translated into families or societies that are extremely poor or extremely rich.

1. In families, which can be described as extremely poor, with a very low level of satisfying all needs (including the most basic ones as nutrition), the increase in income is primarily intended for lower-level goods, thanks to which survival is possible. Then there is an increase in demand for food goods and it is relatively faster than for higher-order goods. As a result, food expenditure is growing not only in absolute terms, but also in relative terms.
2. In the case of extremely rich families, the increase in income is not allocated to satisfying nutritional needs, because their saturation level is already very high. It is even possible that, with an increase in income, there will be a fall in expenditure on food products, in the absolute sense, due to the allocation of expenses for the purchase of luxury goods.

In connection with the above, one can formulate a thesis that, according to Engel's law, it will claim that the standard of living of the family (or society) is higher, the smaller the percentage share of expenditures on basic goods. In a society characterized by high incomes, consumers spend relatively much more on higher-order goods, and definitely less on basic goods. In low-income societies, the opposite is true.

Examples of Engel's law

• In the modern world, Engel's law is manifested in the increasing demand for services and luxury goods as income rises. For example, as income increases, households tend to allocate a greater proportion of their expenditure to holidays, health, education and entertainment, and a smaller proportion to basic food items.
• Another example of Engel's law in action can be seen in the automotive industry. As incomes rise, households may choose to purchase more expensive vehicles and have them serviced more often, rather than buying and servicing cheaper cars.
• As incomes rise, households may also choose to spend more on higher quality clothing, such as designer brands, rather than cheaper alternatives.
• Finally, higher income households may also choose to purchase more expensive electronics, such as smartphones and laptops, rather than cheaper alternatives.

Advantages of Engel's law

Engel's law is a valuable economic principle that helps us better understand consumer spending habits. It has several advantages, including:

• It helps explain why people tend to buy a larger share of higher-order goods when their income increases. This enables economists to better predict a household's spending in different economic circumstances.
• It demonstrates how the structure of a household's expenditure changes as the average income of that household increases, providing useful insight into how households allocate their money.
• It provides a useful comparison between the spending habits of households with different incomes, helping to identify ways in which governments can best target resources and programs to those who need them most.

Limitations of Engel's law

• Engel's law does not take into account the effect of changes in prices, which can significantly affect expenditure.
• It does not consider the income inequality between households of different sizes, as the law is based on the average income of a household.
• The law does not take into account non-monetary factors such as health, education, and leisure.
• It does not consider the effect of changes in tastes and preferences.
• It does not account for different socio-economic factors such as gender and age.
• It does not consider different regional disparities in income and expenditure.

Other approaches related to Engel's law

Besides Engel’s law, there are several other approaches to studying the relationship between income and consumer spending.

• The absolute income hypothesis: This approach, proposed by John M. Keynes, states that consumer spending is determined solely by the level of income, regardless of its purchasing power.
• The permanent income hypothesis: This hypothesis, developed by Milton Friedman, states that consumer spending is determined by the level of income that people expect to have over a longer period of time, rather than by the current level of income.
• The life-cycle hypothesis: Developed by Franco Modigliani, this approach suggests that consumer spending is determined by the level of income that people expect to have over their entire life cycle, rather than by their current income.
• The relative income hypothesis: This hypothesis, proposed by James Duesenberry, states that consumer spending is determined not only by the level of income, but also by the level of income that other people have.

In summary, there are several approaches to understanding the relationship between income and consumer spending, such as the absolute income hypothesis, permanent income hypothesis, life-cycle hypothesis, and relative income hypothesis. Engel’s law is one of the most prominent approaches to this topic, but it is important to consider other theories as well.

Engel's law — recommended articles

Veblen effect — IS-LM model — David Ricardo — John Richard Hicks — Austrian business cycle theory — Income effect — Natural rate of unemployment — Neoclassical economics — Monetarism

References

• Zweimüller, J. (2000). Schumpeterian entrepreneurs meet Engel's law: the impact of inequality on innovation-driven growth. Journal of Economic Growth, 5(2), 185-206.
• Lewbel, A. (2008). Engel curve. The New Palgrave Dictionary of Economics: Volume 1-8, 1744-1746.
• Perthel, D. (1975). Engel's law revisited. International Statistical Review/Revue Internationale de Statistique, 211-218.