Income Elasticity Of Demand Case Study

Suppose the quantity demanded for a good increase 20% with response to an increase of 10% in income. Then the income elasticity of demand would be,
Ey= (20%)/(10%)=2
The amount which the quantity demanded for a good change in response to a change in income depends on the type of goods. We can distinguish the types of goods as following, Normal goods - Ey > 0 – positive YED Luxury goods - Ey > 1 Necessities - 0 < Ey < 1 Inferior products - Ey < 0 – negative YED
Let’s see how the income elasticity of demand deviates for normal goods and inferior products,
Normal Goods A good is a normal good if the equation for the income elasticity of demand produces a positive result. Then as consumers’ income rises, more amount of that item will
Luxury products which has a high income elasticity can predict greater sales volatility over the business cycle than the necessities which the demand for them is less sensitive to changes in cycle.
Importance of the Concept of Elasticity of Demand
The concept of elasticity of demand plays a major role in government fiscal policy when the government considers imposing taxes on various commodities, government policy making in international trade, making pricing decisions by the business firms etc. The concept of elasticity is also important in judging the effect of devaluation of a currency on its export earnings.
Use in international trade to decide whether to devalue the currency or not
In a country like Sri Lanka where there is a continuous trade deficit due to higher imports than exports, Sri Lankan government may want to decide whether to devaluate its local currency or not to bring a favorable trade balance. The effect of the devaluation is to raise the price of the imported goods and to lower the prices of the exports and thereby increase exports and decrease
A monopolist considers the nature of demand while fixing price of his product. If the monopolist finds that the demand for his commodities is inelastic, he will at once fix the price at a higher level in order to maximize his net profit. In case of elastic demand, he will lower the price in order to increase, his sale and derive the maximum net profit.

Determination of wages
Elasticity of demand also influences the determination of wages as well as the prices of other factors of production. The influence of the elasticity of demand is quite important when a trade union demands a higher wage for the workers.
The rise in wages will raise the price of the commodity produced by them. If the demand for the product is elastic, the rise in price will bring about a large reduction in the quantity demanded which will induce the firm to reduce production. The fall in production will lower the number of workers employed. Thus, the attempt by the trade union to raise wages will cause unemployment among the workers.
Determination of advertisement Expenditure The concept of elasticity provides a guideline to the producers for the amount to be spent on advertisement. If the demand for a commodity is elastic, the producers shall have to spend large sums of money on advertisements for increasing the sales.