Discuss the usefulness to a business of a knowledge of price elasticity of demand and income elasticity of demand. [12]

In terms of income elasticity, knowledge of its value can help the firm make better decisions in terms of production with regards to the economic cycle. If the income elasticity of demand happens to be relatively low and close to 0, then that indicates a very small correlation between incomes and consumption, meaning that the economic cycle is likely to have little to no effect on revenue. However, if the income elasticity of demand happens to be a particularly high value, be it positive or negative, then the firm should pay close attention to its output in relation to the economic cycle. If the product in question has a very high negative value, that would indicate it is an inferior good, whose demand increases with falls in income, thus the firm should aim to produce such a good during times of recession, where incomes are predicted to fall. Alternatively, a high positive value can indicate a superior or luxury good. Thus, the firm should focus its output on such products during times of economic boom where incomes are likely to rise. Beyond this, knowledge of YED can allow the firm to make better decisions in terms of marketing. If the firm finds that their product is a superior good, it is probably wise for them to attempt to advertise to high income customers and sell the product in high-end venues.

However, like all metrics, income and price elasticities of demand have certain limitations. There may be inaccuracies in the calculation process or the sample may be unrepresentative, which would lead to the figures found being misleading and as such can lead to poor decisions being made if the firm relies to heavily on them. Similarly, such values can easily become outdated, meaning new, costly, research needs to constantly be done. This comes at an opportunity cost to the company and it could be argued that company funds would be better spend on other endeavours such developing new products or funding growth. Moreover, the use of such statistics can slow down the decision-making process within the business, thus limiting its ability to react to changes in the market and, as such, lowering its price elasticity of supply, which can hurt the firm’s ability to maximise revenue if the price of the product they are producing increases.

Overall, while the knowledge of price and income elasticities can be invaluable to a firm as it helps the firm make better decisions in regards to pricing and the level and nature of their output, this is as long as the figures used are accurate, up-to-date and used in conjunction with other metrics by competent managers in order to be suitably and promptly interpreted and lead to a decision.