Uses of elasticity of demand. Uses of Income Elasticity of Demand in Business Decision Making 2022-10-19
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Elasticity of demand refers to the extent to which the quantity of a good or service demanded changes in response to a change in its price. This concept is a fundamental principle in economics that has numerous uses in both the private and public sectors.
One of the primary uses of elasticity of demand is in pricing strategy. If a good or service has a high elasticity of demand, this means that a small change in its price will lead to a large change in the quantity demanded. For example, if the price of a gallon of gasoline increases by $0.50, consumers may be more likely to reduce their consumption or switch to alternative modes of transportation, such as public transit or carpooling. In this case, the demand for gasoline is considered to be elastic. On the other hand, if the price of a gallon of gasoline increases by $0.50 but there is only a small change in the quantity demanded, the demand for gasoline is considered to be inelastic.
Pricing strategy is important for businesses because it determines their profit margin. If a business is able to charge a higher price for a good or service, it can increase its profits. However, if the demand for the good or service is elastic, the business may need to lower its price in order to maintain or increase sales. On the other hand, if the demand for the good or service is inelastic, the business may be able to increase its price without significantly impacting sales.
Elasticity of demand is also an important consideration for policymakers. For example, governments may use taxes or subsidies to influence the demand for certain goods or services. If the goal is to discourage the consumption of a particular good, such as cigarettes or sugary drinks, the government may impose a high tax on these products. This would increase the price of the good, which would in turn decrease the quantity demanded. On the other hand, if the goal is to increase the consumption of a particular good, such as renewable energy or locally grown produce, the government may provide a subsidy to reduce the price of the good. This would increase the quantity demanded.
In conclusion, elasticity of demand plays a vital role in pricing strategy and policymaking. By understanding how the demand for a good or service responds to changes in its price, businesses and policymakers can make informed decisions that impact both their own profits and the welfare of society as a whole.
Uses of Elasticity of Demand for Managerial Decision Making
Factors That Affect Price Elasticity of Demand Availability of Substitutes The more easily a shopper can substitute one product for another, the more the price will fall. Calculating the Income Elasticity of Demand: Consider a local car dealership collecting data on consumer demand and car sales for the customers whose average actual income is less than sixty thousand USD during the year. So the manufacturer will find that his total revenue from the sale of the product will fall. Currently, she manages content marketing team of freelancers and doing their business efficiently. Hence, price policy adopted is to charge slightly lower price for goods with elastic demand. However, a part of the cost reduction due to the impact of automation i. On the basis of forecast of national or disposable personal income it is possible to apply income elasticities in estimating the changes in the purchases of consumer goods especially durables.
Importance of Demand Elasticity in Business Economics
The concept of price elasticity of demand has important practical applications in managerial decision-making. The demand for those goods is inelastic and the government known that an increase in the taxes on these goods will not result in large fall in demand and consequently tax revenue. Consumers whose demand is inelastic can be charged a higher price than those with more elastic demand. Input Prices: Distribution of national income between individual members and households of the society is an important matter for the economists and social thinkers. How large a price reduction is necessary to increase sales by 10%? This creates a problem in the area of law enforcement.
Commodities with positive income elasticity of demand are The upward slope implies that the rise in income contributes to a rise in demand and vice versa. However, you can use the income elasticity of the demand calculator for the crucial values for IEod. Airline Deregulation: In the USA there was regulation of airlines in the 1970s. She has 4+ years of experience in digital marketing and specialize in content writing, content marketing and organic search engine optimization. The question here is : What should be the optimal tax on petrol which will reduce consumption by the desired amount? She most recently worked at Duke University and is the owner of Peggy James, CPA, PLLC, serving small businesses, nonprofits, solopreneurs, freelancers, and individuals.
As a result, their overall yield is reduced; the farmers would thus be the losers. The Engel curve of commodities reflects their income elasticity, indicating whether a commodity is low-quality, ordinary or luxurious. Price elasticity of demand is measured as the absolute value of the ratio of these two changes. Formulation of Government Policies: ADVERTISEMENTS: Refers to an important significance of the concept of price elasticity of demand. If this is true, a marginal drop in the price of these items is unlikely cause a fall in the quantity demanded of those items, whereas an increase in income would lead to an increase in the number of V. Finally, at higher levels of income Y 1 and above demand is inelastic again. Similarly, the government may decide their protection or subsidy policy for those goods or products whose elasticity is comparatively high.
For supply, you can measure: 4. This will lead to a fall in the revenue of the farmers. An elasticity equal to zero is said to be perfectly inelastic, when a change in price does not change the quantity demanded. If, on the other hand, demand is highly elastic a reduction in price may cause total revenue to increase. Assuming that there are no costs in producing the product, businesses would simply increase the price of a product until demand falls. When measured, the price elasticity of demand will have an elasticity coefficient greater than or equal to 0 and can be divided into five zones depending on the value of the coefficient.
Paradox of poverty amidst plenty: A bumper crop, instead of bringing prosperity to farmers, brings poverty. Each costs 50 p. A nation will be able to import cheaply those items whose demand in the home market is elastic. If the cross elasticity of demand for any two related goods is negative, the two goods may be considered complementary to each other. The following formula is used to find out the numerical value of the elasticity coefficient: in which P 1 and P 2 represent the new and old prices of the other commodity.
In simple words, items whose demand increases with an increase in revenue and whose market falls with the downfall in income is a regular item, e. However, while taxing such goods, it has also to think of the fact that this may lead to an undue burden upon the consumers. In trying to fix the production target for various goods in a plan, a planner must estimate the likely demand for goods at the end of the plan. The high price of a product with demand remaining the constant helps in generating the large revenue for an organization. Thus two points are illustrated in the diagrams below.
Suppose the government of India decides to reduce consumption of petroleum by 3 billion gallons a year by imposing an excise duty. Since the demand is highly inelastic, consumption will fall only slightly even if price rises very high. The major uses of Importance Description Advertisement Decision A firm incurs promotional spending for its products intending to increase sales volume and profitability. In this case, it can improve its balance of trade without unduly weakening its rate of exchange. The price of the commodity will rise as a result of the tax, but the market will not be inelastic Contract In this situation the pressure on the manufacturers or sellers will be lower.
Practical Applications of Price Elasticity of Demand
If the cross elasticity is greater, the goods are closer substitutes. In fact, in order to determine the effect of changes in business activity, the business economist must have a knowledge of income elasticities. If per capita income or household income is the main determinant of demand for a particular product, this may affect the location and type of outlets. During the depression period, demand for such products decreases rapidly, and vendors are adversely affected. Pricing and nationalization of Public Utilities Public utilities are very important for the daily life of all the people living in the country and generally, their demand is inelastic. On the other hand, if the market for the commodity is elastic, the indirect tax burden is relatively higher on the manufacturers.
