Various uses of income and cross elasticity of demand in business decision-making

The use of income elasticity of demand for a firm’s is to determine the growth opportunities of the firm, useful in targeting marketing efforts, success at different stages of business cycles. Following are the theoretical and practical importance:

1. Estimate the effects of changes in economic activity: During the periods of expansion, incomes are rising and firms selling luxury items that the demand for their products will increase at a faster rate than the rate of income growth.

During a recession, demand may decrease rapidly. Knowledge of income elasticity can be useful in targeting marketing efforts. If per capita or household income is found to be an important determinant of the demand for a particular product, this can affect the location and nature of sales outlets. It can also have an impact on advertising and other promotional activities.

2. Uses in capitalist economics: The concept of income elasticity of demand takes an important place among the analytical tools applied for business research. This concept is of income sensitivity of consumption expenditure. Income sensitivity has a co-efficient which measures the percentage increase in rupee expenditure associated with one percent change in disposable income in the same period. The income sensitivity estimates are of great use in business forecasting.

3. Planned developing economies: In the developing countries like Nepal, as levels of living rise, demand for some commodities is expected to go up much faster than the demand for others. In the earlier stages, income elasticity of demand for food tends to be high. As income rises, there is a shortage of food, which not satisfied, leads to inflation. If the planners know income elasticity of demand for goods and services of general use, steps can be taken to balance demand and supply by using appropriate method.

4. Marketing activity and making market strategy: The concept of income elasticity of demand has important role in marketing activities of the firm. People demand goods and services on the basis of their income level. The level of income of the people affects the location and nature of sales. The high-income elasticity of demand indicates the significant promotional efforts in the business.

It is also useful in making marketing strategy. The business firm should concentrate its marketing efforts in media that reaches to the high-income group of the people.

Importance of Cross Elasticity of Demand

The concept of cross-elasticity is useful for the following main purposes:
  1. Useful in inter-commodity relations: It is important for the firm to be aware of how the demand for its products likely to respond to changes in the prices of other goods; this information is necessary for formulating the firm’s own pricing policy and for analyzing the risk associated with various products. This is particularly important for the firms with extensive product lines, where significant substitution or complementary interrelationships exists between the various products. The concept of cross elasticity of demand is very useful in handling the inter-commodity relations.
  2. Classification of markets and market structure: The classification of markets of commodities and services is mainly based on the concept of cross elasticity of demand of one seller in relation to the other. It is used in industrial organization to measure the interrelationships among industries. The cross price elasticity between the firm’s product and products in related industries is large and positive, the firm, even though it may be a monopolist in a narrow sense, will not be able to raise its prices without losing sales to other firms in related industries.
  3. Importance for anti-monopoly legislation: The concept of cross elasticity of demand has been of practical use in sponsoring anti-monopoly legislation. When a particular seller tries to estimate or buy up substitutes of his own product through unfair means, there is a case of monopoly practice against him. But, it is only of drawing a clear-cut line between fair competition and monopoly, however, it is basic concept of doing so.

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