What is the income elasticity of request? Here’s the full discussion
Consumer revenues can often determine what they buy. Therefore, companies need to be aware of economic factors and consumer behavior to know how and when to sell their products and how much it should be paid for it. In this article, we will discuss what is the elasticity of income, how it works, the type of income elasticity from demand, how to calculate it and how to interpret the results of its calculations.
What is meant by income elasticity from request?
The elasticity of the income from request is how much market demand changes according to the changes in the customer’s income. The ratio is the number of requests / revenue changes.
Businesses use income elasticity from demand to estimate economic growth and potential losses according to market demographics – such as geographical location – and economic shifts.
With this knowledge, businesses can develop strategies how to respond to customer finances, both for their own stability and also, in the way they offer their products.
How is the income elasticity of the request working?
Individual income increases when the economy improves, so demand elasticity increases because income increases more consumers will buy business products.
Elastic items
Demand elasticity mainly affects businesses that rely on greater or unnecessary purchases that can be replaced by consumers, known as “elastic goods or services.” Examples of general elastic goods include:
- Clothes
- Soda
- Car
- Electronic
Consumers do not need these items to survive, and chances are small to buy it if their income decreases.
Example: in a stable market where more consumers buy vehicles, chances are there will be less demand for bicycles. Furthermore, car manufacturers may encourage production by hiring more employees to make more vehicles to answer requests.
On an unstable market where high unemployment, you might see less demand for vehicles and more requests for bicycles or less requests for both. Good car manufacturers and bicycles will strive to match their production and prices with demand levels.
Trends of purchases like this are often monitored by businesses to evaluate business cycles, sales generated in a certain period, and to assist destination.
Goods are not elastic
Not elastic goods or services will always be in demand, because consumers consider it not elastic items necessary and have no way to find substitutions if the item becomes too expensive.
Therefore, businesses know that they can determine the price of these items according to their wishes, both in a stable and unstable economic period. Examples of general inelastic items include:
- Gas
- Food
- Cigarette
Example: In an unstable economy when the unemployment rate may be high, the price of gas or toilet tissue is likely to remain the same, because consumers need both and cannot replace them with other products.
Type of income elasticity from request
Businesses usually measure income elasticity from their product demand as one of the following five causal relationships:
- Height: Increased consumer income causes an increase in product quantity because more individuals can buy products.
- UNITARY: Increased consumer income in line with the quantity requested for a product.
- Low: Increased consumer revenue is less aligned with the quantity requested for a product.
- Zero: The number of products purchased and requested by consumers is the same as their income.
- Negative: Increased consumer revenue causes a decrease in the amount requested.
How to calculate the income elasticity of the request
Income elasticity from requests will be different for every business and requires the following steps. Here, we use an example of a car dealer to work on the process:
1. Calculate changes in average consumer income per year
This step may require several additional market research to determine the average consumer income per year and changes from the previous year.
You have a car dealer and want to calculate the income elasticity of the request to prepare for overall business production and accounting costs for the coming year. You find the average consumer income from last year is 60,000,000 per year and in the past year, the average fell to 50,000,000 per year.
2. Identify product requests before and now
Next, you need to determine the number of items sold and compare it to the previous year.
In this example, demand fell from 20,000 units sold to 10,000 units sold.
3. Pay attention to changes in demand and income
Now, you can calculate changes in demand and income from the previous year compared to this year.
If you divide 10,000 with 20,000 then you will get a 50% change in demand, which is a decline of 10,000 cars purchased from the dealer. If you divide revenue changes, which is 10,000,000 per year, with its original value (60,000,000). Then revenue changes are equal to 16.6%.
4. Divide the change in demand with average income per year
Furthermore, divide the request change with average income per year.
You divide 50% (.5) with 16.6% (166), which is equal to 3.012 or 3 if you round up to integers. The level of 3% income elasticity on request concludes that your customers will buy fewer vehicles from your dealers if they see their income decline.
How do you interpret the wisdom?
A company can see the results of their calculations on income elasticity on demand in different ways. However, the interpretation varies depending on the results they count.
Here is a guide to help you interpret the calculations you make:
1. Determine whether the calculation is positive or negative
If your calculation produces a negative number, it is likely that the customer will buy your product if their income increases. If they have more money and don’t buy more of your products, you need to find out why and how to change your product or strategy for your pricing.
For example, maybe they buy other luxury items. Positive calculations, on the other hand, shows that the more money your customers have, the more your products they buy.
2. Adjust the calculation with the type of goods
Look at various types of goods and how calculations can determine the type of item you sell.
Inferior goods
Inferior goods have calculations of income elasticity on negative demand, which causes a decrease in demand when income increases. Some examples of these items include coffee and store brand products such as cereals or paper towels.
People with higher income tend to buy branded products because they are willing to pay more for what they consider to be a quality product.
Normal goods
Normal goods are the results of positive calculations due to increased income according to product demand. They can be called “items” if they fall between 0 and 1 in calculations because people buy this product despite their income levels such as water or electricity.
Luxury
A luxury item has income elasticity from requests more than one. However, buying habits remain sensitive for buyers of luxury goods because these costs are not important. Therefore, changes in economic activity changes determine whether consumers buy ships, sports cars, or other luxury goods.
3. Review the economic and market conditions to determine the price of your product correctly
It is important for your business to continue monitoring consumer behavior and changes in the average income. The more income they have, the more available funds they have to spend on your product, so make market research as a top priority to measure your target audience income.
Conclusion
- Income elasticity from requests refers to how the demand for goods is related to changes in consumer income.
- Businesses use income elasticity from demand to predict and plan potential changes in pricing, budgeting, and production.
- The formula for calculating the income elasticity of the request is% of the changes in the amount purchased (from one period to another, usually from year to year) divided by% of revenue change.
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