Engel’s Law

Definition

Engel’s Law is an economic theory which states that as a family’s income rises, the proportion of their income spent on food declines, while the proportion spent on other goods such as recreation, education, and luxury items increases. The law is named after the German statistician Ernst Engel. It is used to examine the significant change in expenditure habits as income grows.

Phonetic

The phonetics for the keyword “Engel’s Law” is: “ɛn-gəlz lɔː”

Key Takeaways

1. Engel’s Law asserts that as income rises, the proportion of income spent on food decreases, even if actual expenditure on food rises. In other words, the income elasticity of demand for food is between 0 and 1.
2. The law implies that food is a necessary good, but not to say that expenditure on food does not increase with income. It does, but at a slower pace as compared to income.
3. Engel’s Law is an observation in real life that helps economists understand consumer behavior. It has been observed in most countries regardless of the level of development, but the proportion of income spent on food varies considerably from country to country depending on various humanitarian, economic and geographical factors.

Importance

Engel’s Law is an important concept in business/finance because it provides a key insight into consumer spending behavior that can be influential in determining market trends and economic health. Named after the German statistician Ernst Engel, Engel’s Law posits that as a family’s income rises, the proportion of income spent on food decreases, while the proportion spent on other goods and services—like luxury items, entertainment, education, and healthcare—increases. This concept not only assists in understanding and predicting consumption patterns, but also helps in assessing the standard of living and economic development of a society. Furthermore, it provides crucial information for government and businesses to strategize policies and marketing tactics. Therefore, Engel’s Law is pivotal in improving economic planning, policy making and understanding consumer behavior in business and finance.

Explanation

Engel’s Law plays an important role in understanding economic behavior and predicting consumer spending patterns. Named after the statistician Ernst Engel, this economic theory highlights a significant observation in the relationship between income levels and spending behavior, especially relevant in consumption analysis and economic planning. It allows economists, business analysts, policymakers, and financial institutions to devise strategies adapted to changing consumer behavior. The fundamental purpose of Engel’s Law is to assess how changes in income affect the proportion of income spent on different consumption categories, particularly food. According to this law, as a person’s income increases, the proportion of income spent on food decreases, implying that spending on food is a necessity that does not drastically change with income fluctuations. This insight permits policymakers to establish income distribution policies or marketers to plan their target audience and product prices, taking into consideration the effects of people’s spending patterns in relation to their income levels.

Examples

Engel’s Law is an economic theory introduced by the statistician Ernst Engel in 1857, which states that as income rises, the proportion of income spent on food decreases, while also implying that the proportion spent on other goods (like entertainment, education, health) increases. Here are three real-world examples: 1. Developing Countries: Engel’s Law is often evident in developing nations where a larger portion of income is spent on necessities such as food. As the income levels of these nations increase, the inhabitants begin to spend a smaller proportion of their income on food. 2. Increased Income Levels: If a low-income individual who spends a substantial portion of their earnings on food and necessities gets a better, high-paying job, according to Engel’s Law, the proportion of their income that goes to food will decrease. They may still spend more on food than before, but this increase is not proportional to the income increase. They will probably start spending more on luxury items, technology, services, and investments. 3. Economic Progress Over Time: If we look at historical data, as the economy progresses over time and general income levels rise, the percentage of income spent on food decreases. For example, in the early 20th century, a significant portion of household income in the U.S was spent on food. Fast forward a few decades with economic growth and increases in individual income levels, the proportion of income spent on food has significantly decreased while spending on services, travel, entertainment, or education has spiked.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Income Elasticity of Demand
• Consumer Behavior
• Non-essential Goods
• Standard of Living
• Expenditure Patterns

Sources for More Information

• Investopedia
• Corporate Finance Institute
• WallStreetMojo
• Wikipedia