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Engel Curve

An Engel curve describes the variation of the consumption of a good according to the variation of income. In other words, it describes how the consumption of good changes as the total resources of the consumer like income or expenditure varies, assuming fixed prices. The following figure shows how the consumption of a good X changes with the change in the income.

Engel Curve

 

 

 

 

 

 

 

In the X- axis, income is plotted and in the y axis, the consumption of good X is plotted. The classification of a good into normal or inferior goods is also shown by the Engel curve. Engel curve is derived by Ernst Engel (1857) based on the Engel's law. He showed the variation of household food expenditures with income using the data from Belgian surveys of working class families. The study showed food expenditures rising with rise in income and family size while declining food budget shares with income. This relationship of food consumption with income is called Engel's law.

Based on the :normal">Engel curve, the income elasticity of a good can be calculated, which is the percent change in the consumption of good resulting from a percent change in the income. For goods with income elasticities below zero are called inferior goods while those between zero and one are called necessities and those above one are called luxuries. Based on the original work of Engel, the relevance of the family size in determining the food expenditures, which was confirmed by the later studies also. The utility functions are shown dependent on family size based on the adult equivalence scales. This, in turn, is used for family welfare comparison across households. Engel equivalence scales are the ratio of total expenditures required for equating food budget shares across households. According to the shape invariance assumption, it is suggested that the budget share Engel curves for one type of consumer, is a linear transformation of budget share Engel curves for other consumer types. The Engel curve estimates are affected by the aggregation levels across goods. In addition to these, there are other complications involved in the Engel curve estimation like the variation in the quality of goods purchased, that is unobserved and the chances of violation of law of one price. All these can affect the Engel curve estimates. The macroeconomic demand relationships are significantly affected by the shape of the Engel curve. This is through the equation Qi = Ai + biY by averaging qhi across consumers h, where the Qi and Y be aggregate per capita quantities and total expenditures in the population.

 

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