WONG WEI LIT

WONG WEI LITHS2

Interpretation of Income Elasticity of DemandAccording to Mike Moffatt (2015), the Income Elasticity of Demand (YED) measures the rate of response of quantity demand due to a raise (or even lowering) in consumers income. Based on (Economicsonline.co.uk, 2015), income elasticity of demand shows the effect of a change in income on quantity demanded.Incomeis important because it is the determinant of consumer demand, and YED will precisely show the extent to which changes in income and causes to changes in demand. YED can be calculated using the following formula:

YED =

Source: James, 2015

The implication of revenue and business decisions of income elasticityThe Importance of Income Elasticity in Decision Making

Income elasticity helps to indicate the relationship between sales and consumers' incomes, according Graeme Pietersz, who is a business expert at Moneyterms.co.uk, Small-business sales has a higher chance to be affected and fall when consumers' incomes fall. This can be highly evident in the period of economic recessionary. When recessions occurs, consumers have less disposable income. Some may not even find a job at all. Thus, companies will have to center their marketing strategies and decision making on the statuses of consumers' incomes. (Suttle, 2015)

Elasticity for Managerial Decision MakingEconomists compute a few different elasticity measures, including the price elasticity of demand, the price elasticity of supply, and the income elasticity of demand. Elasticity is normally defined in terms of changes in total revenue since that is of primary importance to managers, CEOs, and marketers. For business managers, a key point in the discussions of demand is what happens when they decide to raise prices for their products and services. It is important to be aware of the extent to which apercentage increasein unit price will affect the demand for a product. With elastic demand, total revenue will become lower if the price is raised. Withinelastic demand, however, total revenue will increase instead if the price becomes higher.The possibility of raising prices and increasing dollar sales (total revenue) at the same time will definitely be attractive to managers. This happens only if the demandcurveis inelastic. Here total revenue will increase if the price is raised, but total costs probably will not increase and, in fact, could even possibly go down. Since the profit is equivalent to the total revenue minus total costs, profit will increase as price is higher when demand for a product is inelastic. It is important to know that an entire demand cure is neither elastic nor inelastic, it only has the specific condition for a change in total revenue between two points on the curve (and not along the whole curve).Demand elasticity is affected by the availability of substitutes, the urgency of need, and the importance of the item according the customers budget. Substitutes are products that give the buyer more choices to pick. Some examples will be that most of the consumers recognize corn chips as a good or homogeneous substitute for potato chips, or even see slicedhamas a substitute for sliced turkey. The more substitutes available, the greater will be the elasticity of demand. If consumers find that those products are extremely different or heterogeneous, however, then a particular need cannot easily be satisfied by substitutes. In contrast to a product with many substitutes, a product with few or no substitutes such as gasoline will have an inelastic demand curve. In similar situation, demand for products that are desperately needed or are very important to a person's budget will normally be inelastic. It is crucial for managers to understand the price elasticity of their own products and services in order to set prices appropriately to maximize their firm profits and revenues. (Advameg Inc, 2015)

Source: James, 2015

References1) Economicsonline.co.uk, (2015).Income elasticity of demand. [online] Available from:http://www.economicsonline.co.uk/Competitive_markets/Income_elasticity_of_demand.html [Accessed 22 Jan. 2015].

2) James, M. (2015).Elasticity. 1st ed. [ebook] Available from: http://agecon2.tamu.edu/people/faculty/mjelde-james/AGEC%20105/document%20105/elasticity.pdf [Accessed 22 Jan. 2015].

3) Moffatt, M. (2015).Income Elasticity of Demand. [online] About.com Education. Available from: http://economics.about.com/cs/micfrohelp/a/income_elast.htm [Accessed 22 Jan. 2015].

4) Referenceforbusiness.com, (2015).Elasticity - percentage, Elasticity for managerial decision making. [online] Available from: http://www.referenceforbusiness.com/small/Di-Eq/Elasticity.html [Accessed 22 Jan. 2015].

5) Suttle, R. (2015).The Importance of Income Elasticity in Decision Making. [online] Small Business - Chron.com. Available from: http://smallbusiness.chron.com/importance-income-elasticity-decision-making-33994.html [Accessed 22 Jan. 2015].Economics Assignment (2015 January)