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IAI Actuarial Core Principles · Business Economics · Business activity, unemployment and inflation

A mid-sized Indian insurer notices that sales of discretionary products such as unit-linked plans fall sharply during recessions but recover strongly in expansions. Which description of this pattern is most accurate?

The products have a high positive income elasticity of demand, so their demand is pro-cyclical. When national income falls in a recession, households cut spending on discretionary financial products by a larger proportion, and when income recovers, demand rebounds strongly.

  1. AThe products have a negative income elasticity of demand and are inferior goods
  2. BThe products have a high positive income elasticity of demand, so demand is pro-cyclicalCorrect
  3. CThe products have zero price elasticity so demand is unaffected by the cycle
  4. DThe products are counter-cyclical because demand rises in recessions
  5. The products show demand driven only by supply-side factors

Explanation

Demand that rises and falls more than proportionately with incomes is income elastic and moves in the same direction as the cycle, which is pro-cyclical. A negative income elasticity would imply demand rises in a downturn, the opposite of what is observed.

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