Engel’s Law

Published Mar 19, 2023

Definition of Engel’s Law

Engel’s Law states that the proportion of income spent on food decreases as income increases, assuming that all other factors remain constant. This empirical observation was first made by German statistician Ernst Engel in 1857 and has been confirmed by many subsequent studies.

Example

To illustrate Engel’s Law, let’s take two families. Family A has an annual income of USD 30,000, while Family B makes USD 70,000. Both families spend USD 4,800 a year on food, which represents about 16% of their income, or 7%, respectively. Now, assume both families get a 20% raise. Family A’s income rises to USD 36,000, while Family B’s income increases to USD 84,000. Because of Engel’s Law, you would expect a change in the allocation of the increased income.

Initially, Family A allocated 16% of their USD 30,000 annual income to food, which equals USD 4800. With the 20% raise, their annual income increased to USD 36,000. If they still spent the same proportion of their income on food, they would now allocate only 13.3% of their income to food. Thus, even though they have more money, the percentage of money spent on food decreased. Meanwhile, Family B initially allocated the same amount of their income to food, which was about 7%. With the same raise, they would now have an income of USD 84,000 and could spend up to USD 5,760 on food while still spending 7% of their income.

Why Engel’s Law Matters

Engel’s Law is important because it helps us to understand how people’s spending behavior changes as their income increases. As individuals earn more money, they tend to spend a smaller percentage of their income on food and a larger percentage of it on other goods and services, such as housing, healthcare, education, and entertainment.

This law has crucial implications for individuals, businesses, and policymakers, especially when it comes to understanding how people’s spending changes in response to economic growth, inflation, or government interventions. Therefore, understanding Engel’s Law can help people make more informed decisions about their finances and help policymakers craft policies that are better suited to addressing economic challenges.