The Asymmetry of the Income Effect in Relation to Consumption

ABSTRACT

The following report is a survey study that explores my hypothesis of the asymmetry of the income effect upon consumption. This study empirically shows that the income elasticity with respect to consumption, compared to its value of approximately 1.0 during income decrease, is below 0.5 during income increase. From my analysis of the factors that determine the value of income elasticity, I was able to determine that the factors that determine the "presence of reaction (whether or not consumption was affected)" and, among the cases in which a reaction was present, the factors that determine the "extent of reaction (the extent to which consumption was made to rise or fall)," were different. Furthermore, I found that the main factors that determine the reaction to income rise and the main factors that determine the reaction to income decline are also different. I infer this to be the cause of the asymmetry that we currently observe in the reactions.

The key points are 1) that, in the case of falling incomes, the downside risks of income play an important role in amplifying the rate of consumption decline in response to income decline, and 2) that, in the case of rising incomes, supply factors (e.g., the appearance in the past year of a product or service that one wished to have) become important in accelerating the rate of consumption in response to income rise. Thus, presently, in regard to the cause of the asymmetry in the income elasticity of consumption, while the factors of downside risk remain large, the supply side factors are small.