Chapter 6, Problem aWYWL

To determine

To Explain:

The usefulness of the concepts of price and income elasticities of demand.

Concept Introduction:

Price Elasticity of Demand:

The degree of responsiveness of the quantity demanded in response to the change in the price of the product.

Income Elasticity of Demand:

The degree of responsiveness of the quantity demanded in response to the change in the income level of the consumers.

Explanation of Solution

The concept of price elasticity of demand is significantly useful for business people, farmers, laborers, and government policymakers. Business firms take decisions on product pricing based on their price elasticities. Input prices, especially the wages of the labor are determined by the elasticities of their outputs. The lower is the elasticity of demand of output, the higher is their wages. In case of international trade, the concept of elasticity finds many applications. It helps the government to regulate taxes on imports, assists in the determination of tariffs, or in issuing exemptions and monitoring the value of the currency. In the domestic front also, the concept of elasticity assists the government policy-makers to decide on imposing of taxes on goods and services.

The income elasticity of demand helps in classifying goods into categories such as normal goods (when income elasticity is positive) and inferior goods (when income elasticity is negative). Based on the value of income elasticity, normal goods can be again classified as luxury goods and necessities. These classifications are important for any business decisions. Income elasticities are also used to know about the stages of the business cycle and to forecast demand.