We use cookies to give you the best experience possible. By continuing we’ll assume you’re on board with our cookie policy

The Practical Application of Price Elasticity and Income Elasticity of Demand Essay Sample

essay
The whole doc is available only for registered users OPEN DOC
  • Pages:
  • Word count: 749
  • Category: income

Get Full Essay

Get access to this section to get all help you need with your essay and educational issues.

Get Access

The Practical Application of Price Elasticity and Income Elasticity of Demand Essay Sample

There are several uses of Price Elasticity of Demand that is why firms gather information about the Price Elasticity of Demand of its products. A firm will know much more about its internal operations and product costs than it will about its external environment. Therefore, gathering data on how consumers respond to changes in price can help reduce risk and uncertainly. More specifically, knowledge of Price Elasticity of Demand can help the firm forecast its sales and set its price. Sales forecasting: The firm can forecast the impact of a change in price on its sales volume, and sales revenue (total revenue, TR).

For example, if Price Elasticity of Demand for a product is (-) 2, a 10% reduction in price (say, from $10 to $9) will lead to a 20% increase in sales (say from 1000 to 1200). In this case, revenue will rise from $10,000 to $10,800. Pricing policy: Knowing Price Elasticity of Demand helps the firm decide whether to raise or lower price, or whether to price discriminate. Price discrimination is a policy of charging consumers different prices for the same product. If demand is elastic, revenue is gained by reducing price, but if demand is inelastic, revenue is gained by raising price. Non-pricing policy: When Price Elasticity of Demand is highly elastic, the firm can use advertising and other promotional techniques to reduce elasticity.

INCOME ELASCITIY OF DEMAND:

In economics, income elasticity of demand measures the responsiveness of the demand for a good to a change in the income of the people demanding the good, ceteris paribus. It is calculated as the ratio of the percentage change in demand to the percentage change in income. For example, if, in response to a 10% increase in income, the demand for a good increased by 20%, the income elasticity of demand would be 20%/10% = 2.

Interpretation

A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the demand and may lead to changes to more luxurious substitutes. A positive income elasticity of demand is associated with normal goods; an increase in income will lead to a rise in demand. If income elasticity of demand of a commodity is less than 1, it is a necessity good. If the elasticity of demand is greater than 1, it is a luxury good or a superior good. A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the demand of a good. These would be sticky goods. Income elasticities are closely related to the population income distribution and the fraction of the product’s sales attributable to buyers from different income brackets. Specifically when a buyer in a certain income bracket experiences an income increase, their purchase of a product changes to match that of individuals in their new income bracket.

If the income share elasticity is defined as the negative percentage change in individuals given a percentage increase in income bracket, then the income-elasticity, after some computation, becomes the expected value of the income-share elasticity with respect to the income distribution of purchasers of the product. When the income distribution is described by a gamma distribution, the income elasticity is proportional to the percentage difference between the average income of the product’s buyers and the average income of the population. Many necessities have an income elasticity of demand between zero and one: expenditure on these goods may increase with income, but not as fast as income does, so the proportion of expenditure on these goods falls as income rises. This observation for food is known as Engel’s law.

Types of income elasticity of demand

There are five possible income demand curves:

1. High income elasticity of demand:

In this case increase in income is accompanied by relatively larger increase in quantity demanded. Here the value of coefficient Ey is greater than unity (Ey>1). Eg: 20% increase in quantity demanded due to 10% increase in income.

2. Unitary income elasticity of demand:

In this case increase in income is accompanied by same proportionate increase in quantity demanded. Here the value of coefficient Ey is equal to unity (Ey=1). Eg: 10% increase in quantity demanded due to 10% increase in income.

3. Low income elasticity of demand:

In this case proportionate increase in income is is accompanied by less than increase in quantity demanded.

We can write a custom essay

According to Your Specific Requirements

Order an essay

You May Also Find These Documents Helpful

Consumption and distribution of income Economic

Through the study of production, consumption and distribution of income Economics enables me to learn the more pressing matters which happens in society which is the misallocation of resources. By studying Economics I wish to explore the subject deeper which would enable me to fully grasp how Economics can be harnessed to reduce inequality and to increase employment. Reading further into the subject enabled me...

A Study on Budget and Budgetary Control

The best method to monitor variance between actual and budgeted performance is “Budgetary control”. According to Brown & Howard, “Budgetary control” is “a system of cost control based on comparing actual performance with the budgeted and acting upon results to achieve maximum profitability”. Monitoring the organization’s performance by continuously comparing the actual results with the budgeted figures is of vital importance in any manager’s role....

Accounting Assignment: Clubs

1. A major part of the club’s income is Membership fees. This is a fee paid by members. It is paid annually at R120 for juniors and R450 for adults. The Membership fees is a fixed amount so that along with additional income it covers the clubs expenses. There are usually Membership fees outstanding as well as people who pay in advance. Entrance fees is...

Managerial Economics

Price Elasticity: Price Elasticity is used to explain the degree of responsiveness of the demand for a product to a change in its price. Ep=Percentage change in quality demanded/Percentage change in price (Ep=Price Elasticity) Practical applications of Price Elasticity: 1)Helps in fixing the prices of different goods: It helps a producer to fix the price of his product. A higher price is charged if the...

Macroeconomics Case

Real GDP refers to Gross Domestic Product It measures the total income of everyone in the economy (adjusted for the level of prices) comments Mankiw (2002). GDP tells the economists, the policymakers as well as the common man the nation’s total income and the total expenditure on its output of goods and services. (Mankiw, 2002) Being an important variable that measures the performance of an...

Get Access To The Full Essay
icon
300+
Materials Daily
icon
100,000+ Subjects
2000+ Topics
icon
Free Plagiarism
Checker
icon
All Materials
are Cataloged Well

Sorry, but copying text is forbidden on this website. If you need this or any other sample, we can send it to you via email.

By clicking "SEND", you agree to our terms of service and privacy policy. We'll occasionally send you account related and promo emails.
Sorry, but only registered users have full access

How about getting this access
immediately?

Become a member

Your Answer Is Very Helpful For Us
Thank You A Lot!

logo

Emma Taylor

online

Hi there!
Would you like to get such a paper?
How about getting a customized one?

Couldn't Find What You Looking For?

Get access to our huge knowledge base which is continuously updated

Next Update Will Be About:
14 : 59 : 59
Become a Member