Does Wal-Mart Sell Inferior Goods?

"I feel we are well positioned for an economic downturn. Our low prices and low-cost business model should give us an advantage over other retailers if things get more difficult for consumers." --Wal-Mart's CEO Lee Scott (Kavilanz 2007) I. INTRODUCTION In this paper, I test for the aggregate-income elasticity of revenues at Wal-Mart and Target using panel data for 1997--2006. I find that Wal-Mart's revenues fall during good times, whereas Target's rise during good times. Inferring income elasticities of demand from these estimated income elasticities of revenue, consumers view purchases at Wal-Mart as inferior goods, whereas purchases at Target are normal goods. A well-established cross-sectional fact is that Wal-Mart's shoppers have relatively low incomes compared to, say, Target's shoppers. (1) In a 2005 survey by the Pew Research Center for the People and the Press, 53% of respondents reporting annual earnings below $20,000 said they shopped at Wal-Mart "regularly," compared with 33% of respondents earning more than $50,000 (Pew Research Center for the People and the Press 2005). The average annual household income among Wal-Mart shoppers is $40,000-45,000, roughly equal to the U.S. median household income, compared with $60,000 for Target shoppers (Mui 2005). Confirming this pattern, Figure 1 plots the frequency of shopping at Wal-Mart (and Target)--"often," "sometimes," or "never," based on survey evidence--for households with incomes below $40,000 and above $70,000. (2) Shopping frequencies at Wal-Mart are higher for all income groups because the chain's penetration is higher, but the likelihood of shopping at Wal-Mart "often" falls with income whereas the likelihood of shopping at Target "often" rises with income. This cross-sectional evidence does not establish that a given household increases its shopping at Target and decreases its shopping at Wal-Mart as its income rises. If Wal-Mart stores are located in lower-income areas, for example, shopping at Wal-Mart may be a normal activity and still consistent with the cross-sectional evidence. Despite this distinction, the claim has been made that Wal-Mart sells inferior goods in the technical sense of the term--goods for which demand increases when income falls. The goal of this paper is to evaluate the "inferiority" of Wal-Mart's goods using appropriate data and methods. I use aggregate data on personal disposable income as a measure of consumer income and publicly available data on sales per store at both Wal-Mart and Target. By construction, the aggregate elasticity I estimate is a weighted average of individual households' elasticities of expenditure and can be interpreted as the "average" household's income elasticity of expenditure on Wal-Mart's and Target's wares. This elasticity of expenditure is an upper bound on the elasticity of demand at Wal-Mart if Wal-Mart's prices are not any more elastic with respect to income than other stores' prices. Evidence presented in the Appendix in this paper suggests that Wal-Mart's prices are, if anything, less elastic with respect to income than prices at other stores, which implies that the income elasticity of expenditure for Wal-Mart's goods is even more negative than my estimates suggest. [FIGURE 1 OMITTED] Holding relative prices constant, two effects of income on store revenues work in opposite directions. On the one hand, a negative income shock may send some shoppers who normally shop at more upscale retailers to discounters, thus increasing revenue at the discount retailers. On the other hand, people who already shop at discounters curtail their spending as well. The aggregate effect depends both on the proportion of households of the two types and on the income elasticity of demand for each group. If the income shocks are not uniform across types, the relative size of the income shock matters, too. Ideally, this question would be addressed using household panel data in which household's time-invariant characteristics as well as shoppers' choice sets are controlled for and changes in income are matched with changes in purchasing patterns. …