Discretionary good

What Is a Discretionary Good?

A discretionary good is a non-essential product or service that consumers may purchase when they have sufficient disposable income after covering their basic needs. These goods and services are often considered wants rather than necessities, making their demand highly sensitive to economic conditions and individual consumer confidence. The concept of discretionary goods is a fundamental component of consumer economics, helping to categorize spending patterns and understand consumer behavior within an economy. Unlike essential items like food and housing, the purchase of a discretionary good can be easily postponed or forgone without significant immediate hardship.

History and Origin

The classification of goods into essential and non-essential categories has roots in early economic thought concerning household budgets and spending patterns. As economies developed and moved beyond subsistence, the distinction became increasingly relevant. The Industrial Revolution in the mid-19th century in Western Europe and the United States, for example, enabled the mass production of a wider variety of goods, making more items accessible to a growing urban middle class with increasing means⁵. This historical shift paved the way for a more nuanced understanding of consumer goods.

Economists categorize consumer goods broadly into durable goods, nondurable goods, and services, with discretionary goods often falling across these classifications depending on their non-essential nature. For instance, while most food is a necessity (nondurable), gourmet meals or exotic ingredients could be considered discretionary. Similarly, a car (durable good) might be a necessity for commuting in some areas but a luxury or a second vehicle could be a discretionary good. Encyclopaedia Britannica defines consumer goods as tangible commodities purchased to satisfy current wants and needs, and distinguishes between durable goods (long lifespan), nondurable goods (short lifespan), and services (intangible)⁴. This framework helps contextualize where discretionary items fit within broader consumer spending.

Key Takeaways

• Discretionary goods are non-essential items or services whose purchase is optional and can be deferred.
• Demand for discretionary goods is highly sensitive to changes in consumer income and overall economic activity.
• During periods of economic recession or uncertainty, spending on discretionary goods typically declines sharply.
• These goods often exhibit high price elasticity of demand and income elasticity of demand.
• Examples include luxury vacations, designer clothing, entertainment, and high-end electronics.

Formula and Calculation

While there isn't a direct "formula" for a discretionary good itself, its economic characteristics, particularly its responsiveness to changes in income and price, are quantifiable through elasticity measures. The two most relevant measures for a discretionary good are price elasticity of demand and income elasticity of demand.

The Price Elasticity of Demand (PED) measures the responsiveness of the quantity demanded for a good to a change in its price. For discretionary goods, PED is typically elastic, meaning a small change in price leads to a proportionately larger change in quantity demanded.

A PED value greater than 1 (in absolute terms) indicates elastic demand. For example, if the price of a luxury good like a high-end watch increases by 10%, and the quantity demanded falls by 20%, the PED would be -2.

The Income Elasticity of Demand (YED) measures the responsiveness of the quantity demanded for a good to a change in consumer income. Discretionary goods, particularly durable goods like new cars or home renovations, typically have a high positive income elasticity, meaning as income rises, demand for these goods rises more than proportionately.

A YED value greater than 1 indicates that the good is a "luxury" or highly discretionary item, often classified as a superior good. For instance, if a consumer's income increases by 5% and their spending on fine dining increases by 15%, the YED for fine dining would be 3.

Interpreting the Discretionary Good

The interpretation of a discretionary good centers on its sensitivity to economic shifts and individual financial health. When consumers feel financially secure, with stable employment and increasing disposable income, they are more likely to purchase discretionary items. Conversely, during economic downturns, such as a recession, these purchases are often the first to be cut from household budgets. This makes discretionary goods important indicators of overall economic sentiment and consumer spending trends.

Businesses operating in the discretionary sector often experience greater volatility in sales compared to those in consumer staples. Understanding how consumers prioritize their spending, based on factors like perceived job security and savings levels, is crucial for businesses and economists analyzing market trends.

Hypothetical Example

Consider Sarah, who has a monthly budget. After paying for her rent, groceries (a nondurable good), utilities, and transportation, she has $500 remaining. This $500 represents her discretionary income.

Sarah has two options for how to spend this discretionary amount:

1. Option A: A new gaming console. This costs $400. This is a clear discretionary good. It's not essential for her survival or basic living.
2. Option B: A weekend getaway. This involves booking a hotel and activities, costing $450. This is also a discretionary service.

If Sarah receives a bonus at work, increasing her discretionary income, she might choose to purchase the gaming console and still have funds left for other optional spending. However, if she experiences an unexpected expense, like a car repair, she might decide to forgo both the gaming console and the trip, allocating her limited funds to the more pressing need. This demonstrates how financial changes directly influence the demand for a discretionary good.

Practical Applications

Discretionary goods play a significant role in various aspects of finance and economics. In investment analysis, sectors that produce discretionary goods, such as automotive, luxury retail, travel, and entertainment, are often categorized as "consumer discretionary" industries. These sectors are closely watched by investors as their performance can signal broader economic health. During periods of economic growth and high Gross Domestic Product (GDP), these companies tend to thrive.

Economic policymakers also monitor spending on discretionary goods as a key indicator. A sharp decline in discretionary consumer spending can be an early warning sign of a looming economic recession or a decrease in consumer confidence. For example, during economic hardship, spending shifts towards essential items, while discretionary spending declines sharply³. The National Bureau of Economic Research (NBER), the official arbiter of U.S. business cycles, considers various factors including real personal consumption expenditures when dating recessions, acknowledging the importance of consumer spending patterns in economic downturns².

Furthermore, understanding the demand for discretionary goods is vital for businesses in their pricing strategies and product development. Products with high demand elasticity mean that sales can be significantly impacted by changes in price or income, requiring careful market analysis.

Limitations and Criticisms

One of the primary limitations in defining a discretionary good is that the distinction between "necessity" and "discretionary" can be subjective and vary based on individual circumstances, cultural norms, and economic development. What is considered discretionary for one household may be a necessity for another. For instance, a reliable internet connection might be viewed as a discretionary expense by some, but for those working remotely or seeking educational opportunities, it's an essential utility.

Another criticism arises during economic downturns. While consumers generally cut back on luxuries, there's a "paradox of thrift" where a widespread reduction in discretionary spending can exacerbate an economic slump by reducing overall supply and demand. Even in cautious times, there can be room for discretionary spending, but consumers tend to prioritize value and often switch to private label or lower-cost retailers for some items while still splurging on small treats¹. This indicates that consumer behavior isn't always a straightforward cut-off but rather a re-evaluation of perceived value.

Moreover, the classification can be fluid over time. Items that were once considered pure luxuries, like televisions or smartphones, have become ubiquitous and arguably more essential for daily life and communication for many households. This evolving nature presents a continuous challenge for economists and market analysts in precisely categorizing and predicting consumer behavior.

Discretionary Good vs. Necessity Good

The fundamental difference between a discretionary good and a necessity good lies in its essentiality and how its demand responds to economic changes.

Confusion often arises because some goods can fall into both categories depending on context or specific characteristics. For example, clothing is generally a necessity. However, high-fashion designer clothing is a discretionary good, whereas basic utilitarian clothing is a necessity. The distinction therefore often hinges on the price point, branding, and the consumer's primary motivation for the purchase.

FAQs

What happens to discretionary goods during a recession?

During a recession, demand for a discretionary good typically declines significantly as consumers face reduced disposable income, job insecurity, and general economic uncertainty. Households prioritize essential spending, cutting back on non-necessary purchases.

Are all durable goods considered discretionary?

No, not all durable goods are considered discretionary. While many durable goods like luxury cars or high-end electronics are discretionary, essential durable goods such as basic household appliances (e.g., a refrigerator or washing machine) might be considered necessities, especially if they are replacements for broken essential items.

How do businesses adapt to changes in demand for discretionary goods?

Businesses in the discretionary sector often adapt by offering discounts, introducing more affordable product lines, enhancing value propositions, or focusing on cost-cutting measures during economic downturns. They also closely monitor consumer confidence and broader economic indicators to anticipate shifts in consumer spending.