Practical Application of Price Elasticity and Income Elasticity of Demand

Practical application of price elasticity of demand is as follows:

•Production planning – It helps the producer to decide about the volume of production. If the demand for his products is inelastic, specific quantities can be produced while he has to produce different quantities if the demand is elastic. •Helps in fixing the prices of different goods – It helps a producer to fix his price of his product. If the demand of his product is inelastic he can fix a higher price and if the demand is elastic he has to charge a lower price. Thus price increase policy is to be followed if the demand is inelastic in the market and price decrease policy is to be followed if the price is elastic. •Helps in fixing the rewards for factor inputs – Factor rewards refer to price paid for their services in production process. If the demand for any product is elastic then the producer needs to pay higher reward for it and vice versa.

•Helps determine foreign exchange rates – Exchange rate refers to the rate at which currency is converted into the currency of other country. Helps exchange between two countries,. •Helps determining the terms of trade – It is the basis of deciding the terms of trade between two nations. The terms of trade implies the rate at which domestic goods are being exchanged for foreign goods. •Helps in fixing the rate of taxes -Taxes are compulsory for every citizen which should be paid periodically without expecting any direct benefit from it. We can determine the taxes of the product as per its elasticity in the market. •Helps in declaration of public utilities – Public utilities are those institutions which provide essential goods to general public at economic prices. The govt may declare a particular industry as public utility or nationalize it if the demand for its products is inelastic. •Poverty in the midst of plenty – The concept explains the paradox of poverty in the midst of plenty. A bumper crop like rice may bring in poverty instead of prosperity as the product is inelastic.

Practical application of income elasticity of demand is as follows:

•Helps in determining the rate of growth of a firm – if the growth rate of the economy and growth income of people is reasonably forecasted we can predict the expected increase in sales of a firm and vice-versa. •Helps in demand forecasting of a firm – It can be used in estimating future demand provided that the rate of increase in income and the increase for demand are known. Hence it helps in forecasting activities of a firm. •Helps in planning and marketing – The knowledge of income elasticity of demand is essential for production planning, formulating market strategy, deciding advertising expenditure and nature of distribution channel in the long run. •Helps in sustaining stability in production – Proper estimation of different degrees of income elasticity for different types of products helps avoiding over production or under production of a firm. One should also know if the rise or fall of income is temporary or permanent. •Helps in estimating construction of houses – Increase in income also helps housing programmes in the country.