Journal of Business & Economic Studies, Vol. 16, No.

2, Fall 2010
Computers and Packaged Software: Necessary or Luxury Goods?
Longitudinal Empirical Analysis and Its Implications
Min Lu, Robert Morris University
Steven Thompson, University of Richmond
Yanbin Tu, Robert Morris University
Abstract
This study investigated the income elasticity of demand for computers and packaged software in
the United States from 1992 to 2003. Using cointegration analysis with quarterly time series
data, we found that computers and packaged software are necessary goods to private firms,
luxury goods to households, and inferior goods to government agencies. By using flexible least
squares, we showed that these income elasticities generally are stable over the time horizon. We
found that while private firms represent the bulk of computer and packaged software sales,
growth in household expenditure is the precursor to growth in the overall market. The extended
analysis on IT and communication products and services also suggests broader IT products are
luxury products to households. The managerial implications of our findings are discussed.
Key Words: Income Elasticity, Necessary Goods, Luxury Goods, Cointegration, Flexible Least
Square (FLS)
JEL Classifications: D6/E5/O16
Introduction
Organizations engaged in the manufacturing and sales of computers and packaged
software and other IT products have been forced to confront a dynamic and challenging market
place. The intensity of this competition is evidenced by rapidly falling prices over time, short
product life cycles, and high rates of firm failure and consolidation. In this environment, the
ability to attract and retain consumers, while maintaining reasonable profit margins, is critical to
the success of any organization.
Since price reductions have the potential to negatively impact revenue and profits, they
should be performed judiciously so that the price is reduced by the smallest amount required to
stimulate the desired level of demand. One strategy firms use to achieve this objective is to
incorporate how consumer demand changes in response to changes in price. Another alternative
not frequently used is to incorporate how consumer demand changes in response to changes in
consumer income level. To this end, product life-cycle theory and the theory of income elasticity
of demand provided a useful framework for understanding how the demand for a product will
change in response to changes in consumer budget. We proposed that providing organizations
with information that enables them to segment more effectively their consumers into groups that
exhibit similar purchasing behavior will facilitate better pricing and marketing strategies.
The idea of segmenting customers is not new in the technology sector. Many computer
and packaged software vendors (such as Dell and Microsoft) divide their customers into
categories of home, small business, and large business. However, these segmentations typically
32

Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
are based on observed differences in the type of product or service each group desires. The
implicit assumption when differentiating markets in the fashion of Dell and Microsoft is that
demand is homogeneous within each group. For example, such a strategy would entail the
assumption that both General Electric and the U.S. Department of Defense will display similar
demand patterns because both can be categorized as large businesses. Theoretically and
empirically, we sought to supplement these types of intuitive segmentations by including
additional information that can be used to support and refine their market segmentation strategy.
According to economic theory, the income elasticity of demand describes by how many
percentage points the demand for an item will change when income adjusts by 1%. An income
elasticity of demand greater than 1 suggests that the good is a luxury good. An income elasticity
of demand between 0 and 1 suggests a necessary good, while a value less than 0 implies that the
good is an inferior good.
The objective of this research was to determine whether computers and packaged
software are considered luxury goods, necessary goods, or inferior goods by households, private
firms, and government agencies respectively. The rationale for this segmentation is that we had
reason to suspect that each of these sectors would exhibit different demand patterns. In addition,
we sought to gain some insights into the role of each of these market segments in terms of the
overall growth of the market for computers and packaged software. These represent important
research topics because understanding the nature of income demand elasticity is critical to
developing effective pricing strategies as well as design and versioning decisions. Likewise,
understanding how each of these segments contributes to the growth of the overall market is
important in that it provides organizations with useful information regarding how to cultivate and
profit from each segment. Many factors, including global economic trends, impact the incomes
of households and the revenues of businesses and government agencies. Understanding the
relationship between income and demand enables IT vendors to meet market demand with less
risk of over-production and the associated price cuts that typically follow.
This study investigated the income elasticity of demand for computers and packaged
software in the U.S. from 1992 to 2003 at the industrial level. This study found that computers
and packaged software are necessary goods to private firms, luxury goods to households, and
inferior goods to government agencies. The flexible least squares method also was used to
estimate the dynamic changes of income elasticities over time, the results showed that the
changes in income elasticity are generally stable, becoming slightly higher during 1992 to 1996,
but dropping back during 1996 to 2003. We also found that while private firms represent the
largest market for computers and packaged software, household expenditure drives overall
market growth. Further analysis of data for IT and communication products and services also
suggested that IT products are considered luxury products to households. The managerial
implications of our findings and the associated marketing strategy recommendation also were
discussed. To the best of our knowledge, this study was the first to apply the economic theory of
income elasticity to marketing research on IT product sales. The study contributes to the existing
literature by providing insights into the relationships between IT products sales and expenditures
of different customer categories, and associated marketing strategies to promote IT product sales.
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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
Literature Review
Researchers in economics and marketing have conducted extensive empirical research on
the income elasticities of a number of goods and services, ranging from energy (Bohi, 1981)) to
agricultural products (Klonaris & Hallam, 2003; Mdafri & Brorsen, 1993) to healthcare
(Freeman, 2003; Getzen, 2000; Matteo & Matteo, 1998). In these settings, the theory of income
elasticity has been used to illuminate the purchase behavior patterns of consumers in order to
provide marketing and pricing insights. Within the realm of information goods and technology
products, Bakos and Brynjolfsson (1999, 2000) used income elasticity to evaluate optimal
product bundling strategies for information goods.
While income elasticity of demand provides insights into how demand will change in
response to changes in the consumers budget, price elasticity provides insights into how
demand, for any budget level, will respond to changes in price. For a given product, price
elasticity is expected to change over time as the product moves through its life cycle. Product life
cycle theory describes the evolution of the first-purchase growth of new products and is the
subject of extensive research. Early marketing researchers, including Clifford (1965), Levitt
(1965), Cox (1967), Polli and Cook (1969), and Scheuing (1969), described in detail the four
major stages in a products life cycle: introduction, growth, maturity, and decline.
Subsequent research has focused on incorporating additional factors into the product
diffusion process in order to obtain better insights into the products life cycle. Diffusion models
that incorporate price changes were developed by Robinson and Lakhani (1975), Bass (1980),
Jeuland (1981), and Kalish (1985). Researchers also investigated the impact of advertising and
the joint impact of product benefits, price, income, and information on product diffusion
(Horsky, 1990; Horsky &Nate, 1988; Horsky & Simon, 1983 ). Additional research focused on
the impact of changing demographics and economic conditions as they impact diffusion speed
(Van den Bulte, 2000).
From the economics theory (Silberberg 1990), we can see that how a consumer perceives
a good (as luxury, necessary, or inferior) is determined by his utility function and the prices of
the goods. Also, price elasticity of demand is related to income elasticity of demand. As a
general rule, keeping price and income fixed, higher income elasticity of demand implies higher
price elasticity of demand and vice-versa. Of interest here is that income elasticity and the
associated price elasticity are expected to increase as a product moves through its life cycle. We
expected this association for two reasons. First, consumers knowledge about the product,
especially regarding availability, deals, prices, and promotions, is higher in the later stages of the
life cycle (Tellis, 1988; Tellis & Fornell, 1988). Second, the early adopters who are the source
of product sales during the introduction stage tend to have higher incomes and are more likely to
exhibit lower price elasticities than late adopters (Nagel, 1987; Onkvisit & Shaw, 1989; Simon,
1979). Taken together, the results of these studies indicated that income elasticity of demand is
likely to be higher and the associated price elasticity of demand is likely to be more negative in
the later stages of the life cycle.
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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
Research Hypotheses, Data Description, and Stationary Test
A priori, we expected that computers and packaged software would be necessary goods to
private firms (see Brynjolfsson & Yang, 1996, for a detailed summary of the productivity
benefits of IT investments, and Dewan & Min, 1996, for a discussion on the substitution of IT
for other factors of production). In general, we expected that computers and packaged software
would be considered luxury goods by households, since rarely is computing seen as a critical
household function. Finally, we expected that computers and packaged software would be
considered normal goods by government agencies. This expectation, while government agencies
would certainly seem interested in the types of productivity gains that are obtainable from
investments in computers and packaged software, was based on the notion that the strict budgets
that government agencies face may cause them to exhibit price sensitive behavior.
As a result of those assumptions, we suspected that private firms would tend to be early
adopters of computers and packaged software because their income elasticity of demand is quite
low. Households, on the other hand, would tend to be later adopters of computers and packaged
software because their income elasticity of demand is higher. Government agencies reasonably
could be expected to exhibit behavior somewhere between that of private firms and households.
This assumption led us to the following research hypotheses:
Hypothesis 1 (H1): Computers and packaged software are necessary goods to private
firms.
Hypothesis 2 (H2): Computers and packaged software are luxury goods to households.
Hypothesis 3 (H3): Computers and packaged software are normal goods to government
agencies.
Defining and measuring a utility function can be difficult; therefore, in order to test the
income elasticity of demand empirically, we performed the following regression:
ln Q ln M where Q is the quantity of good, M is income or expenditure and is the
error term. Taking the derivative with respect to M, we obtained (Q / M )(M / Q) . Thus,
the coefficient of lnM is the income elasticity of demand for Q.
The data used in this study spanned the period beginning with spring 1992 and ending
with spring 2003. They included season-adjusted end-of-month sales of computers and packaged
software, the consumer price index, season-adjusted quarterly real gross private domestic
investment, season-adjusted quarterly real government consumption expenditures and gross
investment, and season-adjusted quarterly real personal consumption expenditures (durable and
non-durable goods). Since existing literature (Davidson, Hendry, Srba, & Yo, 1978; Heckman,
1974) suggested a strong, positive relationship between expenditure and income, expenditure
could be used a proxy for income in this empirical study. Table 1 contains a detailed description
of the data and the sources.
In the analysis, we used personal expenditure on both durable and non-durable goods
because computers and packaged software products can be considered both durable and non35

Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
durable goods. To remove inflationary distortion in the quarterly data used in this study, data in
nominal values were adjusted to real values by taking January 1992 as the base month.
Table 1. Data Sources
Data
Adjusted Estimates of Monthly
Retail Sales For Computers and
Packaged software in million$ from
January 1992-March 2003
Season-adjusted Quarterly Real
Gross Private Domestic Investment
Spring 1992-Spring 2003
Season-adjusted Quarterly
Personal Expenditure on Durable
and Non-durable Goods in billion $
during Spring 1992-Spring 2003
Season-adjusted Quarterly Real
Government Consumption
Expenditures & Gross Investment
Spring 1992-Spring 2003
Monthly Consumer Price Index
from January 1992-March 2003
Description
Retail sales of new computers, computer
peripherals, and prepackaged computer
packaged software in combination with
repair and support services
Gross private domestic investment consists
of fixed investment and change in private
inventories
Household Expenditure on Durable and
Non-durable goods
Source
US Census Bureau, US
Department of
Commerce
Bureau of Economic
Analysis, US Department
of Commerce
Bureau of Economic
Analysis, US Department
of Commerce
Bureau of Economic
Analysis, US Department
of Commerce
Bureau of Labor
Statistics, US
Department of Labor
1
2
3
4
5
Current consumption expenditures by
general government, and gross investment
by both general government and
government enterprises.
Changes in the prices paid by urban
consumers for a representative basket of
goods and services.

As time series variables with unit roots might have led to spurious estimates, we tested
the data to see whether they were stationary before performing any regressions. Following
McKenzie and Brooks (1999), we conducted one informal and two formal tests for unit roots. An
informal and intuitive test was to inspect the Auto-Correlation Function (ACF) and Partial AutoCorrelation Function (PACF) diagrams. Figure 1 presents the ACF and PACF for monthly log
values of sales of computers and packaged software for households. (We got similar ACF and
PACF patterns for private firm and government expenditure.) Figure 1 suggests non-stationarity
existed in the data since two readily distinguishable features could be found. First, the ACF
exhibited a very slow rate of decay as the lag length increased, and second, the PACF contained
a large and statistically significant spike at the one period lag, which almost disappeared in later
periods.
The popularly used formal tests for non-stationarity in the literature were the Augmented

Dicky-Fuller (ADF) and Phillips-Perron (PP) tests for unit roots. Table 2 presents the results of
the ADF and PP tests for each of the four-time series. From Table 2, we can see that two
versions of the ADF test clearly failed to reject the null hypothesis of a unit root in each series
because the test value was less than the MacKinnon critical value at the 5% level in each case,
with the exception being the case without intercept or trend. Two of the three PP tests generated
values that were less than the critical test value at the 5% level, with the exception being the test
without intercept or trend. This again suggested the presence of non-stationarity in sales of
computers and packaged software, private investment, household expenditure, and government
expenditure.
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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
Figure 1. ACF and PACF in Level
Figure 2. ACF and PACF in the 1st Difference

Table 2. ADF and PP Stationary Tests

ln(Sales)
ADF None
ADF with intercept, lag=1
ADF with intercept and time
trend, lag=1
PP None
PP with intercept, lag=1
PP with intercept and time
trend, lag=1
1.856664
-3.46043*
-1.422291
2.035518*
-3.596799**
-1.474923
LnGovt
3.344127**
2.325275
-1.496555
3.729758**
2.324234
-1.572668
LnFirm
2.147586*
-1.879745
-0.574134
2.958978**
-2.49416
-0.765934
LnPersonal
7.456688**
-0.0577
-1.487703
11.63844**
0.21702
-2.073801

Note. Critical-statistics in parentheses for ADF and PP stationarity testing at 5% level. A * means
significant at 5% level. A value greater than the critical t-value indicates non-stationarity.

The conventional way to eliminate a unit root is to take differences until stationarity is
established,that is, statistical significance of the calculated value of the unit root test is achieved.
V Vt 1
The first difference in a logarithmic series is calculated as ln Vt ln Vt ln Vt 1 t(when
Vt 1
Vt is small, where V is a variable), which approximates the continuously compounded growth
rate. The correlogram of the first difference for sales of computers and packaged software is
presented in Figure 2.
From Figure 2, we can see that, in contrast to values in level, for values in the first
difference the decay in the ACF and large spike in the PACF are gone. (We got similar ACF and
PACF patterns for private firm and government expenditure in first difference.) Table 3 presents
the details of the ADF and PP tests for variables in the 1st difference. We find evidence to
suggest the stationarity of data in the 1st difference. Except for one test value for household
expenditure without intercept or trend, all other test values were significant at the 5% level, and
most were significant at the 1% level. This result was not sensitive to the presence of an intercept
term and trend. Hence, the ADF and PP tests clearly indicated that the growth rates for
computers and packaged software sales, private firm investment, household expenditure, and
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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
government expenditure were stationary. Therefore, we concluded that the four quarterly time
series variables in level were integrated in order one, I(1), and may be cointegrated with each
other.
Table 3. ADF and PP Stationarity Tests of Growths
ln(Sales)
ADF None
ADF with intercept, lag=1
ADF with intercept and time
trend, lag=1
PP None
PP with intercept, lag=1
PP with intercept and time
trend, lag=1
-3.529453**
-3.845304**
-5.3438**
-6.510732**
-6.995803**
-8.569229**
LnGovt
-3.380924**
-4.772383**
-7.184025**
-5.292179**
-6.785432**
-8.327112**
LnFirm
-2.950766**
-3.434337*
-3.862062*
-4.876947**
-5.551396**
-5.972427**
LnPersonal
-1.475985
-5.045682**
-4.94211**
-2.80163**
-8.9008**
-8.777275**

Note. Critical-statistics in parentheses and brackets for ADF and PP stationarity testing at 5% and 1%
levels respectively. A * means significant at 5% level. A ** means significant at 1% level. A value
greater than the critical t-value indicates non-stationarity.

Testing Income Elasticity of Demand

Long-Term Relationships: Cointegration Analysis
The Standard and Poors (S&P) Transparency and Disclosure Survey data, which
covered 460 companies included in the S&P 500 index, was used as a data source. The S&P data
covered those same 460 companies in the index for the periods June 30, 2000, and September 30,
2000. Companies that may have had some regulatory inquiries regarding their public filing were
excluded from the data set, as were companies with incomplete information. To control for
endogeneity, we separated the periods used to measure the level of disclosure activity and the
other variables. This separation resulted in the loss of 33 companies primarily due to missing
financial and ownership data. With these reductions, the final sample contained 374 firms.
Cointegration analysis is used to investigate long-term trends and was first introduced in
the seminal work of Engel and Granger (1987). We began with a formal introduction of
cointegration analysis due to Hold and Perman. (1994). Let { y1 , y 2 ,..., y n } be the set of
variables of interest. Now suppose that each variable in the set is I(1). Let Yt be a column vector
where the i th element is equal to the value of y i at time t. Therefore, Yt is a vector composed of
the k variables, all of which are I(1). It is generally true that any linear combination of the
elements of the vector will also be I(1). That is, the linear combination
38

Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
a1 y1t
a y ik
'

a Yt 2 2t a i yit is generally I(1). However, it is possible that this linear combination,

.. .. i 1

a k y kt
resulting from some specific a vectors, might be I(0). If this happens, we say there is a
cointegration among the set of non-stationary variables y1 , y 2 ,..., y n and the vector a is called
the cointegrating vector.
We used EViews Version 4.0 to conduct the Johansen-test and run cointegration
regressions. Table 4 presents the Johansen-test for the cointegration of the sales of computers
and packaged software, household expenditure, private investment, and government expenditure.
The test results suggest that there was one cointegrating relationship as both trace and max were
greater than the critical values at the 1% level.
Table 4. Johansen-test for Cointegration
Hypothesized
No. of CE(s)
None **
At most 1
At most 2
At most 3
Eigenvalue
'

trace

max

61.635627
24.536516
5.8912135
0.4116917
CV
(trace 5%)
47.21
29.68
15.41
3.76
CV
(trace 1%)
54.46
35.65
20.04
6.65
37.099110
18.645303
5.4795217
0.4116917
0.5865886
0.3584933
0.1223126
0.0097543
CV
(max
5%)
27.07
20.97
14.07
3.76
CV
(max
1%)
32.24
25.52
18.63
6.65
Normalized Cointegrating Coefficients: 1 Cointegrating Equation
LRETAILLFIRMLGOVTLPERSONA C
L
1.000000-0.9652536.429268-4.194467-23.75761
(0.58692)(1.52144)(1.20326)

Log likelihood493.2568

Note. *(**) denotes rejection of the hypothesis at 5%(1%) significance level.

L.R. test indicates 1 cointegrating equation(s) at 5% significance level.
CE: Cointegration Equation, CV: Critical Value.

Normalizing the cointegration with respect to the coefficient for sales, the cointegrating
equation (t-values in parenthesis) expresses the following relation:
ln(Sales) =23.75761+0.965253 ln(Firm) + 4.194467 ln(Household) - 6.429268ln(Govt)
(-1.94325)
(-3.04616)
( -3.04616)
This cointegration equation is a long-term relationship amongst the sales of computers
and packaged software, private firm investment, household expenditure, and government
expenditure. The estimated coefficients of all three variables were significant at the 1%
confidence level. The sign of the estimated coefficient for firm investment was positive as
39

Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
expected, which suggests computers and packaged software are normal goods to private firms.
The estimated coefficient of 0.965253 was less than 1, which further suggests that computers and
packaged software are necessary goods to private firms. This implies that as private investment
increases, the share allocated to investments in computers and packaged software will decrease.
Similarly, if private investment decreases, the actual amount invested in computers and packaged
software will decrease, but the budget share will increase. The intuition behind this result was
that a private firm will only spend whatever amount is necessary on computers and packaged
software. If the amount of investment capital at the firms disposal increases, the organization
will tend to use the additional money for other things, thereby decreasing the overall proportion
of capital spent on computers and packaged software.
The sign of the estimated coefficient of household expenditure was positive, which
suggests computers and packaged software are also normal goods to households. The estimated
coefficient value of 4.194467 further suggests that computers and packaged software are luxury
goods to households. This finding implied that as household expenditure increases, the budget
share allocated to the purchase of computers and packaged software will increase. Conversely, if
household expenditure decreases, the budget share allocated to the purchase of computers and
packaged software will decrease rapidly.
The sign of the estimated coefficient of government expenditure was negative. This result
was contrary to our initial expectation that computers and packaged software are normal goods to
government agencies. The negative sign suggests that computers and packaged software are
actually inferior goods to government agencies. The implication is that as total government
expenditures increase, the actual amount spent on computers and packaged software will
decrease. This was a sharp contrast to a necessary good where only the proportion of budget
share allocated will decrease but the amount of investment, in terms of dollars spent, will still
increase.
Short-Term Relationships: Flexible Least Squares
We next looked at how these income elasticities evolved over time. Obviously, changing
markets will affect income elasticities in the short-term. However, in order to validate the
robustness of the results obtained from the cointegration analysis, we needed to look at the nature
of the changes in income elasticities over the entire time horizon. The time paths can be
estimated by using the Flexible Least Squares (FLS) method developed by Kalaba and
Tesfatsion (1988, 1989, 1990). The FLS technique is a useful tool for analyzing the relative
stability of regression coefficients (sensitivities) by showing the smooth changes of the
coefficients over time. It relaxes the time-constant restriction on coefficient estimates in the OLS
method, and recursively estimates the time paths of the coefficients of a regression model.
For the given observations, the FLS approach minimized the squared residual
measurement errors and the squared dynamic error. The collection of all FLS coefficient
sequence estimates exhibited the efficient attainable trade-offs between residual measurement
error and residual dynamic error. The time paths of coefficient estimates traced out by FLS
revealed unanticipated qualitative movements in each coefficient estimate at dispersed points in
time, and consequently illuminated all major changes over time.
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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
FLS is then a helpful tool that can be used to shed some light on dynamic linkages
because it can describe the time paths of correlations. Wood (2000) demonstrated that FLS is
superior to other methods in that it enables the analyst to diagnose the magnitude of coefficient
variation and detect which particular coefficients are changing. For more technical discuss about
FLS, please see Tesfatsion and Veitch (1990) and Lutkepohl (1993), and for the FLS application
please see He (2001).
Our FLS results in Table 5 revealed consistent results of coefficient change (sensitivity)
for the income elasticities of demand for computers and packaged software to private firms,
households and government agencies. The values chosen for range from 0.1 to 0.9 in
increments of 0.1, and the mean FLS coefficients for private firms ranged from 0.031087 to
0.036135 with the standard deviation of means ranging from 0.0005369 to 0.00053248 and
coefficient of variation from 0.11587 to 0.09805. When = 0.50, the private firms coefficient
is 0.031609, the standard deviation of means is 0.0005364 and the coefficient of variation is
0.11386.
Table 5. OLS and FLS Estimating Results
FLS results

Constant

-8.1009
[0.0000366]b
<-0.0003035>c
-8.0974
0.00003665
-0.0000303
-8.0929
0.00003664
-0.00003037
-8.0869
0.00003663
-0.00003038
-8.0786
0.0003662
-0.00003041
-8.066
0.00003660
-0.00003044
-8.0451
0.00003653
-0.00030503
-8.0032
0.00003653
-0.00003061
-7.8775
0.00003635
-0.00003097
a

Firm

0.031087
[0.0005369] b
<0.11587> c
0.031169
0.0005368
0.11555
0.031274
0.0005367
0.11514
0.031413
0.0005366
0.1146
0.031609
0.0005364
0.11386
0.031901
0.0005362
0.11276
0.032384
0.0005358
0.11099
0.033342
0.0005349

0.10763
0.036135
0.0005324
0.09805
a
a

Household

2.1308
[0.00054018]
<0.00169> c
2.1367
0.0005401
0.0016957
2.1365
0.00054
0.0016956
2.1363
0.0005399
0.0016954
2.136
0.00053978
0.0016952
2.1355
0.00053955
0.0016949
2.1347
0.00053917
0.0016943
2.1331
0.00053841
0.0016932
2.1285
0.00053617
0.0016898

Govt
-1.1388
[0.00052124] b
<-0.0030703> c
-1.139
0.00052117
-0.0030694
-1.1393
0.0005211
-0.0030683
-1.1396
0.00052099
-0.0030668
-1.14
0.0052084
-0.0030648
-1.1407
0.00052062
-0.0030617
-1.1418
0.00052026
-0.0030565
-1.1441
0.00053497
-0.0030462
-1.151
0.00051736
-0.0030153
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9

Note. t-value in parenthesis. a : Mean of Coefficients; b : Standard Deviation of Mean; c :Coefficient of

Variation.

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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
Figure 3. Time Variations of the Coefficient for Households Income Elasticity
Figure 4. Time Variations of the Coefficient for Private Firms Income Elasticity
Figure 5. Time Variations of the Coefficient for Governments Income Elasticity (In Absolute Value)

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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
The detailed time path for the sensitivity over the entire sample period with = 0.5 is
presented in Figures 3-5. From Figures 3-5 we can see that the variations of the three elasticities
over time were not large,, which meant that our findings that computers and packaged software
are necessary goods to private firms, luxury goods to households, and inferior goods to
government agencies are quite stable.
Compared to the other two, the income elasticity of demand for private firms is more
stable. In addition, the slight changes of elasticities in the three markets are also similar. From
the first quarter of 1992 to the third quarter of 1996, the elasticities generally increased. After
that, the elasticities declined except for a jump in the fourth quarter of 2001.
Factors Driving Market Growth
As discussed in Section III, the 1st differences of the four time series are stationary.
V Vt 1
whenInterestingly, the first difference is also the growth rate as ln Vt ln Vt
ln Vt 1 t
Vt 1
Vt is small, where V is a variable. Since the 1st differences of the time series are stationary, we
can conduct the following growth regression (t-value in parentheses):
Sales = -0.012388 + 0.116083*Firm + 2.786206*Household - 0.987026*Govt
R-Square=0.18 (0.473192)(2.840639)(-1.154037)
The sign of the coefficient for private firms was positive and the sign of the coefficient
for government agencies was negative, but neither was significant, suggesting that either private
firms are not a significant factor driving the growth of computer and packaged software sales or
that government agencies insignificantly block the growth of sales. The sign of the coefficient
for households is positive and significant at = .01. This seems to clearly point to household
expenditure as the driving force in the growth of computer and packaged software sales. The
implication of this finding is that although the bulk of computer and packaged software sales
were attributable to the expenditure of private firms, household expenditure is the driving force
behind overall market growth.
Information Technology and Communication (ITC) Products and Services:
An Extended Study
After finding that computer and packaged software are luxury goods to households, we
extended our study to include information technology and communication (ITC) products and
services. ITC products and services are typically substitutes for, or complements to, computers
and packaged software, and our goal was to determine if ITC products and services also were
treated as luxury goods by households.
To test our hypothesis that ITC products and services are also luxury goods to
households, we collected the annual household final consumption expenditure, annual
expenditure on communication, and annual expenditure on audio-visual photographic and
information processing equipment in the U.S. from 1989 to 2001 (OECD, 2002). We then
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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
regressed log total expenditure on log communication expenditure, log expenditure on audiovisual photographic and information processing equipment, and log ITC respectively. The results
are listed in Table 6.
Table 6. Income Elasticity of Budget Share
Independent Variable
Communication
Audio-Visual, Photographic and
Information Processing Equipment
ITC
Note. t-value in parenthesis.
Constant
12.14134
10.63859
10.82769
Inverses of Income Elasticity
0.579876 (15.21729)
0.193878 (29.04472)
0.295841 (28.63917)
R2
0.95860
0.98829
0.98710

From Table 6, we can see the inverses of three income elasticities of budget share are
significant with the values between 0 and 1, which suggest the income elasticities are more than
1. The R2 is over 0.95 for each case, which suggests households consider IT products and
services (including ITC and audio-visual photographic products) to be luxury goods.
Discussion
Product Life Cycle and Income Elasticity of Demand
While income elasticity of demand provides insights into how demand will change in
response to changes in the consumers budget, price elasticity provides insights into how
demand, for any budget level, will respond to changes in price. For a given product, price
elasticity is expected to change over time as the product moves through its life cycle. Product life
cycle theory is based largely on the seminal work of Bass (1980) that described the evolution of
the first-purchase growth of new products and was the subject of extensive research. Early
marketing researchers, including Clifford (1965), Levitt (1965), Cox (1967), Polli and Cook
(1969), and Scheuing (1969), described in detail the four major stages in a products life cycle:
introduction, growth, maturity, and decline (see survey in Hashimoto, 2003).
A better understanding of income elasticity of demand and price elasticity of demand in
combination with the product life-cycle stage can enable more effective and more profitable
marketing campaigns. For example, if a product is necessary to some consumers, they are more
likely to be early adopters and more likely to purchase the product during the introduction and
growth stages of the product life cycle. In addition, these consumers are less price sensitive so a
price premium can be charged. Luxury buyers tend not to have an urgent need for the product,
and are more likely to buy the product during the growth or maturation stages. Luxury buyers are
also more sensitive to prices, with lower prices likely to spur demand and higher prices likely to
precipitate a drop-off in demand. It is, therefore, important to know the current life-cycle stage of
each product and the primary consumers of each product at each stage of the product life cycle.
In conjunction with product life-cycle theory, evaluating income elasticity of demand can
help to identify the primary consumer groups at each stage. Groups that consider IT products to
be necessary goods, such as private firms, are more apt to purchase early in the product life cycle
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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
and be less price sensitive. Groups that consider IT products to be luxury goods, such as
households, are more likely to purchase later in the product life cycle and be more sensitive to
price changes.
Implications and Recommendations
This study provided several interesting insights. First, we found evidence to suggest that
the market segmentation strategy of partitioning consumers into individual consumers and
business consumers was supported not just in terms of product interest but also in terms of
demand patterns. In addition, we found that while private firm investment represented the bulk of
computer and packaged software sales, growth in household expenditure was the precursor to
growth in the market as a whole.
Vendors of computers and packaged software can take advantage of these findings by
strategically setting prices for the household and private firm markets. For products that are
offered to both the households and private firms (e.g., personal productivity software such as
Microsoft Office or personal computers) vendors can charge private firms higher prices
because these products are perceived as necessary goods by the private firm, which will cause it
to be less price sensitive. In addition, vendors should set low prices for households for three
reasons. First, since these products are considered to be luxury goods to households, a low price
will result in an income effect that will stimulate more household consumption. Second, the
high-income elasticity of households implies that the purchase incentive created by lowering the
price will result in higher revenue. Third, because growth in the household sector is a precursor
to growth in the overall market, stimulating growth in this segment will enhance overall market
growth.
The most interesting finding of this study was that computers and packaged software are
inferior goods to government agencies. This finding was counter-intuitive but may be explained
by the fact that the government overall is interested in total social welfare such as a high
employment rate and the stability of the economy, which is in contrast to private firms that
continuously seek to improve productivity and profitability. However, that computers and
packaged software are inferior goods to government agencies implies that when the economy is
experiencing recession (and the budgets of government agencies likely decline), government
agencies will be inclined to spend more money on computers and packaged software.
Significantly, the increased expenditure of government agencies during bad economic times can
help computer and packaged software vendors stabilize their sales during periods of recession
when private firms and households are more likely to spend less. The spending patterns of
government agencies can act as a buffer to mitigate volatility in the sales of computers and
packaged software. This might be attributed to the fact that most government agencies budget
expenditure a year or more in advance and then hold to that budget, which is somewhat different
from a private firm. A private firm also will budget in advance, but will modify the budget
quickly in response to an economic shock. This tendency to stay on budget may explain our
findings regarding the income elasticity of demand for government agencies.
A better understanding of income elasticity of demand and price elasticity of demand in
combination with the product life-cycle stage can enable more effective and more profitable
marketing campaigns. During the introductory stage of the product life cycle for computers and
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Journal of Business & Economic Studies, Vol. 16, No. 2, Fall 2010
packaged software, the consumer base tends to be comprised predominantly of private firms.
Therefore, vendors initially should target private firms and allocate the bulk of their marketing
and advertising efforts towards building demand in this sector. Once the growth stage begins,
marketing and advertising efforts should shift to cultivate demand within the household sector.
Our FLS analysis showed that the time paths of the income elasticity of demand for
private firms, households, and government agencies are quite stable, impling that our findings
are not short-term anomalies, but are representative of stable, long-term buying patterns. Thus,
computer and packaged software vendors can expect the recommendations made here to be a
viable basis for long-term marketing and advertising strategies. The extended study on IT and
communication products suggests our findings and recommendations are generalizable to many
other IT products and to many markets outside the U.S.
Conclusions, Limitations, and Future Research
This paper investigated the income elasticity of demand for computers and packaged
software in the U.S. during the period spanning 1992 to 2003. By using cointegration analysis,
this study found that computers and packaged software are necessary goods to private firms,
luxury goods to households, and inferior goods to government agencies. Flexible least squares
was used to estimate the stability of the income elasticities, and estimated results showed that
changes in elasticities were quite stable. We also find that while the majority of revenues are
obtained from private firms, household expenditure is the driving factor in the growth of
computer and packaged software sales. In order to determine how well our findings generalized
to other IT products and other markets, we extended our analysis to include IT and
communication products and services. We then discussed the managerial implications of our
findings and provide the associated marketing strategy recommendations.
While interesting, the work presented here was not without limitations. First, this work
incorporated only computers and packaged software sales and associated services; it does not
address customized software developed specifically for a given organization. Firms that engage
in this type of custom development should not generalize these results without first corroborating
the presence of these trends in their own sales data. Second, the conclusions reached in this paper
may not be valid across all types of computers and packaged software or across all government
agencies and private firms. Any organization selling computers and packaged software would
be well advised to conduct a similar analysis using sales data for the subset of private firms and
government agencies that represent their predominant customer base. Additionally, using microdata to investigate these types of nuances is a worthwhile area for future research.
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William Hudson, Ph.D., is a Professor of Finance at St. Cloud State University in St. Cloud,
Minnesota. He earned his Ph.D. in Finance from the University of North Texas in 1996. Dr.
Hudson has held teaching positions at the University of Mary Hardin-Baylor, Minot State
University, and Western Illinois University. Dr. Hudson's research focuses on corporate finance
and finance pedagogy. He has published numerous articles in academic journals such as
Managerial Finance, Advances in Financial Education and the Journal of Business and
Economic Perspectives

Min Lu, Ph.D., is an Assistant Professor of Economics in the School of Business at

Robert Morris University. Her current research interests are international finance,
monetary economics, e-commerce, and business economics. Min Lu received her Ph.D.
from the University of British Columbia, Vancouver, Canada. She joined Robert Morris
University in 2007. She was also a financial analyst for the International Division of the
Bank of China. Her research papers have appeared in the International Journal of
Electronic Commerce, International Journal of Internet Marketing and Advertising,
International Journal of Value Chain Management, and International Journal of
Monetary Economics and Finance, among others. She is the recipient of many awards.
George McCabe, Ph.D., is an emeritus professor of finance at University of Nebraska-Lincoln.
He has published extensively in leading journals in finance and was previously editor of the
Quarterly Journal of Business and Economics (now the Quarterly Journal of Finance and
Accounting).

Steven Thompson, Ph.D., is an Assistant Professor of Management in the Robins School

of Business at the University of Richmond. His current research interests include global
information technology strategy, health care information systems, and disaster response
logistics. His research has appeared in journals such as Operations Research, Information
Systems Research, Decision Sciences, Communications of the ACM, and others. Dr.
Thompson earned his Ph.D. from the University of Connecticut.
Yanbin Tu, Ph.D., is an Assistant Professor of Marketing in the School of Business at
Robert Morris University. His current research interests include Internet marketing,
database marketing, CRM, electronic commerce, banking management, and financial
service marketing. His work has appeared in International Journal of Electronic
Commerce, International Journal of Internet Marketing and Advertising, International
Journal of Value Chain Management, Online Information Review, and Communications
of the ACM, among others. Dr. Tu has worked in the Bank of Shanghai in China. He
earned his Ph.D. from University of Connecticut, U.S.A.
Ken Yook, Ph.D., is an Associate Professor of Finance at Johns Hopkins Carey Business School.
He has published articles in leading journals such as Journal of Business, Journal of Financial
Research, Journal of Portfolio Management, Journal of Business Finance and Accounting, The
Quarterly Review of Economics and Finance, Journal of Applied Business Research, Financial
Practice and Education, and Journal of Financial Education. He holds a Ph.D. in Finance from
University of Nebraska. He has taught at St. Cloud State University and Penn State before joining
Johns Hopkins.

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