According to a report by Bain, quoted in The Economist blog, the number of luxury consumers has more than tripled in under 20 years, to around 330 million people in 2013. Spending has risen at a similar rate, to an estimated €217 billion ($300 billion). Around 130 million of these consumers are in emerging markets, with 50 million of those in China.
Microeconomics, which simplifies and models social behaviour, has the answer at hand. In economics when demand for a product rises by a greater proportion than income, such good is referred to as a luxury good. A Louis Vuitton bag, a pair of Jimmy Choo shoes, dinner in a Michelin-star restaurant are luxury goods. (By contrast, if demand for a product changes less than proportionately to income, such a product is a necessity. That’s public transport, a mobile phone contract, a pint of lager.)
When Chinese entrepreneurs stroke gold, their income went up. Let’s imagine businessman Li, whose income has doubled over a year. Just because he now has twice the money, it does not mean he’ll be buying twice more rice than he did last year. However, his demand for luxury goods, such as imported whisky, he likes very much, has increased tenfold.
Percentage change in demand divided by the percentage change in income is called income elasticity of demand and measures the relationship between demand for a particular type of good and income.
Luxury goods have income elasticity of demand greater than one: in our expensive whisky example, it is nine (900% divided by 100%). Necessities have income elasticity of demand between zero and one: if Li’s income rose by 100% and his consumption of rice increased only by 30%, rice has income elasticity of demand of 0.3. For the so-called inferior goods income elasticity of demand is negative: Li is so rich now, he can afford a car and a driver, his demand for public buses in Shanghai has plummeted.
Technicalities aside, it is easy to see that an increase in income causes a greater increase in demand for luxury goods than any other goods.
What happens when income drops? Demand for designer brands, taxi rides, expensive cocktails and opera drops by an even greater factor, due to high income elasticity of demand for such products and services.
How can you apply this lesson to the product or service you are selling? What does it teach you about your own behaviour when you got your first graduate job?