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Interpretation of Income Elasticity of Demand

According 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. Income is 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 =

Economics Assignment (2015 January)

WONG WEI LIT

Source: James, 2015

Economics Assignment (2015 January)

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The implication of revenue and business decisions of income elasticity

The 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 Making

Economists 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 a percentage
increase in unit price will affect the demand for a product. With elastic demand, total
revenue will become lower if the price is raised. With inelastic 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 demand curve is
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

Economics Assignment (2015 January)

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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 sliced ham as 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)

Economics Assignment (2015 January)

WONG WEI LIT

Source: James, 2015

Economics Assignment (2015 January)

WONG WEI LIT

References
1) Economicsonline.co.uk, (2015). Income elasticity of demand. [online] Available
from:
http://www.economicsonline.co.uk/Competitive_markets/Income_elasticity_of_de
mand.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-making33994.html [Accessed 22 Jan. 2015].

Economics Assignment (2015 January)