The Practical Application of Price Elasticity and Income Elasticity of Demand
PRICE ELASCITIY OF DEMAND:
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
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