Planning
If a business knows the income elasticity of demand (YED), it helps it to decide whether to lower or raise prices following a change in consumer incomes. If incomes are falling and YED is positive, a reduction in prices may help compensate for the reduction in consumer demand. If the firm wishes to maximise total sales revenue, it will need to determine the price elasticity of demand in the market and then price accordingly.
A business that sells mainly inferior goods will tend to find that their sales increase during a recession. Subsequently, they can use this information to ensure it has enough stock to satisfy demand. On the other hand, a business that sells luxury products may find that sales fall during a recession. This could result in the business needing to reduce capacity and scale back production levels.
There are differences in income elasticity between the different countries depending on whether it is an emerging or developed economy. There are also different culinary traditions, consumer tastes and preferences. If consumers are loyal to the brand in one market but not in another it may mean that a business will have more power to increase price without a significant decrease in quantity. Also, there may be availability of close substitutes in one market compared to the other.
A firm can forecast the impact of a change in income on sales volume (Q) and sales revenue (P x Q).
Hypothetical Example
For example, a manufacturer in Ireland sells it’s digital cameras in France and Germany. the the sales figures for both countries is shown for year 2020 on the table below. Assume the income elasticity (YED) is +1.8 for both markets.
The firm can then predict the sales figure following change in consumer incomes in each country. (ceteris paribus)
| France | Germany |
|---|---|
| 160,000 units | 220,000 units |
Market research reveals that incomes are forecast to rise by 4% in France and 2.5 % in Germany,. in 2021.
Calculate the expected total sales figures (units) for both markets in 2021?
Workings
- France: If income increases by 4%,then sales revenue will increase by:
(1.8 x 4%) = 7.2%. Sales increase in 2021= (160,000 x 7.2%) =11,250
Sales 2021 =(11250+160,000) =171,520 units
- Germany: If income rises by 2.5%, then sales will increase by:
(1.8 X 2.5%) =4.5%. Sales in 2021 = (220,000X 4.5%) =9,900
Sales 2021= (9,900 + 220,000) = 229,900 units