Income elasticity of demand refers to the sensitivity of the quantity of a product or a service demanded to the change in consumer income, and it is calculated as a change in quantity demanded expressed in percentage divided by the change in incomes also expressed in percentage (Mankiw, 2009). The value of income elasticity helps to evaluate the willingness of consumers to purchase more or less if their incomes increase or decrease. Income elasticity equal to 0 indicates perfectly inelastic demand, which means that consumers buy the product at any income level. Income elasticity between -1 and 0 characterizes inelastic demand, which is not very sensitive to income changes. Alternatively, values above -1 show an elastic demand, which quickly and strongly responds to income changes. Lastly, price elasticity equal to 1 indicates that consumers change consumption by the same percentage as the change in their incomes (Nicholson & Snyder, 2009).
Application of the income elasticity in the real life is limited by a number of economic, political and social factors. That is why in some cases elasticity model cannot fully predict the behaviour of demand in response to income changes. Thus, it is very hard to compute the elasticity for alcohol consumption on a state level. Firstly, the demand for alcohol is not only affected by the change in consumer income in the times of recession. It is also strongly influenced by the psychological factors related to the loss of jobs and the uncertainty about the future. Hence, if the disposable income of state alcohol buyers was reduced by factors other than unemployment, the change in alcohol consumption would not alter as dramatically. Moreover, estimates provided on a state level do not allow distinguishing between high and low areas of alcohol consumption as well as do not show the quality of alcohol purchased and the difference of individual consumption levels. Thus, with a decrease in income, unemployed people may choose to drink more than an average consumer, however, this fact will not be reflected in the aggregate statistics. However, for the purpose of this paper it is possible to estimate that income elasticity of demand for alcohol on the state level is = 3, which shows high elasticity level. The attempts to estimate demand elasticity on the federal level yield even less success. In addition to the abovementioned problems, which characterize state alcohol consumption evaluation, calculating the elasticity of demand on a bigger scale fails to show the differences between different states. As prices, recession impact as well as consumer drinking patters may largely vary across states, any estimates of the federal elasticity of demand for alcohol can only show a very general elasticity level, which is unlikely to reflect the true situation. However, if such general results are required, it is possible to estimate that the country level alcohol consumption has income elasticity of = 4, which is even more elastic than on the state level. It is important to note that in both calculations it is assumed that the percentage change of unemployment reflects the change in consumer income, however this is not necessarily the case, as some other factors, such as welfare policies, may alter the effect of unemployment on incomes.
As it has been calculated above, demand for alcohol both on the state and on the country levels is highly elastic. This fact suggests that alcohol abuse should not be a major problem or even should become less of a problem during recessions. However, it is important to keep in mid the limitations of the proposed calculations. Thus, the decline of the amount of money spent on alcohol may not mean a decline in drinking but a switch of consumers to lower quality alcohol products. Moreover, aggregate estimations fail to reflect the distribution of consumption among population. Thus, if people who managed to retain their jobs decrease their consumption of alcohol in response to the unemployment threat, those, who lost their jobs during the recession, may increase their alcohol consumption significantly. In this case alcohol abuse may become a major problem and governments should consider taking steps to counteract this trend.
References
Mankiw, G. (2009). Principles of economics. (6th ed ed., pp. 90-95). Mason, OH:
South-
Western Cengage Learning.
Nicholson, W., & Snyder, C. (2009). Intermediate microeconomics and its application. (11 ed.). Mason: South-Western College Publications.
