Stephanie Lynn March 7, 2010

Managerial Economics

Impact to Inferior Goods during the Recession

Introduction
A recession is measured by taking into account the quarters of the year rather than
the entire year. On the other hand the depression is calculated as a drop in the GDP by
10% or even higher in the full year. Recessions generally happen more frequently than
depressions. If the economy is diversified then the country recovers quickly from the
shock. When GDP is negative for two consecutive quarters then it is said that recession
has set in. Another word very commonly used in economics is regression. The dictionary
meaning is to go back to a lesser developed period.
Economics being termed a ‘dismal science’ remains rather undecided on these
terms because of various schools contradicting each other. There is no universal
agreement. For instance the GDP might show growth but not so with employment. So
recession might have retreated, as is being said currently in U.S., but the problems in the
housing sector and unemployment continues to be rampant and intense.
Discussion
The recession effects are invariably drastic. Purchasing power lies with the
people and during times of recession people will search for substitutes that are cheaper
considering that their very survival is at stake. The majority of the manufacturing plants
will reduce or cease production because of a drop in demand. This leads to a common
phenomenon in a recession, an increase in unemployment caused by the decline in
manufacturing. Many companies cut back on their staff and have layoffs. In turn, those
people who are jobless fail to find alternative employment.
The recession cycle comes to haunt the country again and again because of fear

about the future. In the U.S., the recent recession has led to a significant drop in the

manufacturing of items such as luxury items and cars. Apprehension about the future

causes the stock markets to fall. Less growth means less profit and this starts off a cycle

of fear.

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 Inferior good
What is meant by inferior good? Goods whose demand goes down when the
income of consumers increase are known as inferior goods. This is in contrast to normal
goods for which the opposite applies and demand for normal goods increases when the
income of consumers increases. Thus goods are termed inferior not because of quality
but because of affordability.
An example of an inferior good is the inner-city bus service. It is cheaper than
travel by air or rail but it eats up more time. When purses are slim bus travel becomes
popular but when pockets are full with there being more money than time, the faster
mode of transport is given preference. Other inferior goods are food stuffs like bologna,
mass marketed beer, frozen dinners, hamburgers etc. But as earnings increase one is apt
to buy more expensive, attractive and nutritious foods.
Geographical influence
There are also cultural and geographical connotations to the meaning of inferior
good. In the Andes the potato is inferior good but in Bangladesh it is not so but rather
expensive and the food for the elite who munch potato chips. Recently a list of inferior
goods was made by scholars from Western Michigan University. It listed some common
grocery items that included imitation Kroger and Tahitian Punch fruit punches, generic
ice cream sold in pails, cosmic brownies and other low cost brand items.
SPAM
Hormel Foods Corporation based in Mower County, Minnesota is noted for its
SPAM brand of luncheon meat. Despite the economic downturn, Hormel is looking to
the future. Earnings from their grocery products and refrigerated foods segments
improved by 9% and 7% respectively while their special and international foods
segments remained flat in 2009. In addition, Hormel did not have to lay off anyone at
their plant in Austin, MN. Across the U.S., they have lost 19,000 employees. Generally
the number of corporate jobs would grow by 40 to 50 positions instead of shrinking by 20
jobs as what occurred in 2009. CEO Jeffrey Ettinger is hopeful that in 2010 the numbers
will pick up again.

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 A new Hormel Foods plant was inaugurated in Dubuque, Iowa in January 2010.
By the close of 2010 the number of employees at this plant is expected to increase from
about 80 employees to 200 employees.
Regression Analysis
Regression Analysis: Sales of SPAM versus GDP growth, GDP per cap, CPI
inflation and Unemployment

Sales volume = 170350 - 2162 GDP growth - 0.06 GDP per cap
- 5353 CPI inflation

There is a negative association with sales volume and GDP growth, DPG per
capital and CPI inflation. This means that sales would decrease when there is GDP
growth but sales would increase when GDP declines. This also applies to changes in CPI
inflation rates. The adjusted R square is 56% meaning that the variation in sales is
explained by the variation in GDP growth, GDP per cap, and CPI inflation taking into
account the sample size and the number of independent variables.

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 Data
(note: sales volume in thousands)

Sales volume
To meet its goal to increase sales for 2009 and to ride the sales increase of some
of its product lines, Hormel has opted for more aggressive advertising strategy. The
grocery food market is not the only industry benefiting from the economic downturn.
Portland Business reported on a few others thriving industries for the latter half of 2008
and the first half of 2009. The auto repair sector increased business by 2.4% while car
dealers noted a decrease of 9.7%. Home remodeling business went up 4.6% for
contractors like electricians, plumbers and HVAC. However, business for new home
builders declined by 5% for this same period.
Grocery stores showed a 6.7% increase in sales as compared to dine-in restaurants
that showed a decline of 3.9% in sales. Among the specialty trade and technical schools,
increased enrollment grew revenue by 7.8%.

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 The most surprising is the increase in sales of dentistry services. Sales increased
2% to 7% as compared to the 5% sales increase in 2007. Perhaps people need to grind
their teeth during recession or again a tax matter might be the cause.
Certified public accountants and accounting firms saw growth of 10.2%. The
accounting industry is among the top 20 sectors in the country that have showed growth
during this recession period.
Other affects
Another surprise is the increase in business activity including sale of products and
services relating to personal care like skin care, make-up, hair salons and barber shops.
Perhaps people need a less expensive diversion since they currently cannot splurge on big
vacations. Another theory that has tried to explain the impact of sales of inferior goods
during a time of economic downturn is the Lipstick Theory. During times of uncertainty
certain products will begin to sell more. After the terror attack of 9/11 the chairman of
Estee Lauder, Leonard Lauder explained that sale of lipsticks had picked up because
during troubled days when the women cannot indulge in luxuries like designer clothes
and costly jewelry they satisfy their craving by opting for something less expensive like
lipsticks. The theory has not been proven but the recent increase in lipstick sales during
this current economic crisis hints at this truth so the theory cannot be totally discarded.
There is no doubt that when days are tough people will stop spending on non-
essentials. But they will hunt for less costly alternatives. Thus during an economic
downturn the best placed firms are those that sell what is termed by economists as
‘inferior goods.’ These are the substitutes for items that are no longer affordable.
Thus focusing on lipsticks instead of spa treatments could keep a business running
successfully. The same can be said about costume jewelry and budget meals that include
simple basics like rice and pasta. The restaurant industry is feeling the pinch of the
recession while sales of recipe books have picked up as families go back to enjoying
home cooked food.
The recession has brought about remarkable success in the bicycle industry. The
increased demand has become noticeable. Shops across the U.S. are reporting strong
sales. People are bringing out their old bikes and giving them a tune-up. Apart from the
gasoline price factor, it is the recession that has pushed up demand for bicycles.

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 Analysis
Inflation and unemployment are both increasing. Real wages have seen no gains
in the last few years while the prices of essentials are rising. This fall in real income may
have spurred the sale of bicycles. The bicycle can be termed an inferior good in the sense
that as income falls the demand for the item increases. Bicycles stand for a radical
cheaper way of commuting in the midst of high food and gas prices and the weak dollar.
BBC research shows that although other sales have gone down, the sale of baked
beans has picked up by 22.6% last December in comparison to December 2007. People
are choosing beans on toast as a nutritional alternative to other exotic meals. So sales of
bread too have picked up. In the bread sector the sales of the standard white sliced ones
have gone up sharply. The latter is an inferior product. When people see their income
rise they will discard these purchases for more premium ones like seeded loaves,
baguettes and croissants.
The sale of champagne fell by 10% in December but the drop in the sale of
sparking wine was modest. This means that those consumers who used to purchase
champagne are now buying sparkling wine; whereas those who used to take the wine are
now opting out causing slight the drop.
Conclusion
Thus, it is evident that there is a definite pattern and it holds true for most
products. The same holds true in regard to olive oil. Previously, olive oil was thought to
be a luxury item but surprisingly sales went up by 6.5% in December in comparison to
December 2007. Why? Has this costly oil become a basic staple? Perhaps people have
become more health conscious and are not making cuts here. Another explanation could
be that people are not buying costlier ready-made dressings but are instead preparing
their own dressings at home with olive oil as one of the ingredients. The olive oil factor
can also be interpreted to mean that people are eating out less and staying at home and
cooking. The idea is that anything to do with simple living and do-it-yourself tasks is
better for you. The recession is seeing the beginning of a stay-at-home socio-economic
scenario similar to the slower and simpler times of the past.

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Sources:

• Bruno, O. (2009). “Credit Availability and Capital Crunch: On the Role of the
Heterogeneity of the Banking System.” Journal of Public Economic Theory, 11(2),
2009. 251-279.
• Inferior good. (10/2009). In Wikipedia, the free encyclopedia. Retrieved February 20,
2010, from http://en.wikipedia.org/wiki/Inferior_good
• Miller, MH. (2008). “Financial Markets and Economic Growth”. Journal of Applied
Corporate Finance, 11(3), 8-15.
• Minford, P. (2009). “Monetary Policy and the Credit Crunch.” Economic Affairs,
29(1), 89-91.
• Popik, Barry. (2009). “Lipstick Index”. Entry from November 1, 2009 in The Big
Apple. Retrieved February 27, 2010, from
http://www.barrypopik.com/index.php/new_york_city/entry/lipstick_index_lipstick_i
ndicator_lipstick_theory/
• “Report: Seven U.S. Industries Thriving.” Portland Business Journal.
http://portland.bizjournals.com/portland/stories/2009/05/11/daily9.html
• Terrones, ME. (2009). “What happens during recessions, crunches and busts?”
Economic Policy, 24(60), 653-700.
• William, WW. (2006). The power of productivity: wealth, poverty, and the threat to
global stability. LA: University of Chicago Press.
• Spam data from Hormel and Hormel SEC filings
• Economic data provided by professor

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