More or Better- The Effect of Quality on Income Elasticity in Tourism Consumption

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More or Better-The Effect of Quality on Income
Elasticity in Tourism Consumption

• Aliza Fleischer
• Department of Agricultural Economics
• Hotel, Food Resources and Tourism Management
  Program
• The Hebrew University of Jerusalem

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Trends in Tourism Consumption

• The quality of tourism goods is on the rise.
  Boutique hotels, unique spas, luxurious BB, and
  spiritual tours with modern amenities are some
  examples of the emerging new high quality
  products
• This means that tourists, in recent years,
  decided to increase the quality of their vacations

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Objectives

• In this paper I estimate the income elasticity
  with quality choice
• The estimations take into consideration the fact
  that some of the households have zero expenditure
  
• I show that income elasticity of demand is
  smaller when quality decision is considered

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Definition of Income Elasticity

• Income elasticity
• change in quantity demanded
• change in income
• If prices are constant
• change in expenditures
• change in income

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Important points in income elasticity study

• Income elasticity shows the sensitivity of
  tourism consumption to changes in income
• In using cross-section data such as Households
  Expenditure Survey one assumes constant prices
• As a result the demand function collapses into
  the Engel curve price elasticities cannot be
  obtained

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Estimations of Income Elasticities in the
Literature

• Davies and Mangan (1992) used the UK family
  expenditure survey. The income elasticity in mid
  point is 2.1. Poor households have elasticity of
  4 and wealthy households elasticity of 1.5.
• Van Soest and Koorman (1987) and Melenberg and
  Van Soest (1996) studied the factors determining
  vacation expenditures in Dutch households. They
  also used cross section data but unlike Davies
  and Mangan (1992) they took into consideration
  the fact that only a fraction of the households
  have non-zero expenditures. In the first paper it
  was found that vacation abroad is a luxury good
  with income elasticity of 2.1 while domestic
  vacations are a basic good with income elasticity
  of only 0.7. In the latter using parametric and
  semi- parametric modeling income elasticity was
  found to be 1.7.
• In works analyzing leisure and recreation
  expenditures based on cross section data (Costa,
  1997 and 1999 Weagley, 2004) similar results
  were found. Income elasticity was found to be
  significantly larger than one.

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Problems with Existing Estimates Assuming
Constant Prices Across Households

1. Income elasticity larger than one implies that if
   a household enjoys an increase in income it will
   increase its expenditures even more on vacation.
   However, since prices are constant it means that
   the increase in expenditures reflects an increase
   in the number of vacation days only. It does not
   reflect changes in the quality of the vacations.
   
2. Polinsky (1977) shows that the econometric
   estimates of the expenditure function using cross
   section data are biased if prices do vary across
   households.

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Unit Value

• The problem of obtaining prices from household
  expenditures surveys was overcome in recent works
  on demand for food.
• Additional data on quantity consumed enabled
  researchers to obtain prices (unit values). This
  is done by dividing expenditure by the number of
  units.
• Using it enables the estimation of price
  elasticity and an unbiased estimation of income
  elasticity.
• The unit value differs from the price of
  homogenous good if we use aggregate commodity
  such as vacation.

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Unit Value

• Expenditure on vacations include hotel nights in
  Israel and abroad, travel abroad and related
  recreation activities. Thus, vacation is a
  heterogeneous commodity whose unit price reflects
  differences in quality
• This means that unlike consumer theory where
  prices of homogenous goods are exogenous the unit
  value as a price is endogenous.
• A higher unit value per day of vacation reflects
  a decision of the household to stay, for example,
  in a luxury boutique hotel rather than a two-star
  hotel. It is a function of income and not
  independent of income like prices of homogenous
  goods.

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Unit Value

• A vacation day during the high season is a better
  quality product than off season because the
  weather is better or it is more convenient in
  terms of vacation policy from school or work.
• In tourism, unit value can vary between
  households because of differences in the quality
  of information-seeking skill.
• Unit values vary across households

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Theoretical Model
Consumer maximizing its utility subject to budget
constraint
Demand is a function of price and income
Price of vacation as a function quality units and
price of unit of quality
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Theoretical Model
Vacations as aggregate commodity
Rewriting of the maximization problem
Demand of aggregate commodity
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Theoretical Model
Expenditures
Unit value
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Empirical Model 1 without unit value with
Selectivity
Decision equation
If I gt0 then the following model holds
Expenditure share equation
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Empirical Model 2Simultaneous Equations Model
with Selectivity
Decision equation
If I gt0 then the following model holds
Unit value equation
Expenditure share equation
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Income Elasticity
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Data

• Household Expenditure Survey 1999
• Additional data provided by the CBS on number of
  vacation days in Israel and abroad enabled
  calculation of unit value
• Total of 5987 out of which 699 reported non
  zero expenditures

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Income Elasticity
Family size elasticity is -1.44 in both models
Price elasticity is -0.33
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Conclusions

• Increase in income leads to increase in vacation
  expenditures
• This increase is affected more from increase in
  the quality of the vacation than from the number
  of vacation days
• This explain the rapid growth we see in quality
  of tourism products