AS Level Economics Paper 2

AS Level Economics Paper-2 (Qamar Baloch)

Discuss the usefulness to businesses of knowledge of price elasticity of demand and
income elasticity of demand.
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Price elasticity of demand refers to the responsiveness of change in quantity demanded
due to change in price. It is calculated through the following formula:
Price elasticity of demand =
The knowledge of price elasticity of demand is of much importance for businesses
because it helps to set pricing policies to earn more revenue and profits.
If the businessman knows the nature of price elasticity of demand then he will charge the
price accordingly.
For example if the demand for the product is elastic then he can increase his revenue by
decreasing the price, because a small decrease in price will lead to a larger increase in
quantity demanded. Consequently, his total revenue will tend to rise. In this situation he
will never increase his price because it will result in a dramatic fall in quantity demanded
and finally total revenue will fall.
On the other hand, in case of inelastic demand, a firm can increase his total revenue by
increasing the price. A large rise in price will bring a smaller decrease in quantity
demanded (i.e. less than proportionate). When demand is inelastic, businessman will
never decrease his price because a fall in price will lead to decrease in total revenue. In
case of unitary elastic demand fluctuation in price will not affect the total revenue. Any
rise or fall in price will leave the total revenue unchanged.
If the demand for a product is perfectly inelastic then a firm can earn more revenue by
increasing the price, because rise in price will lead the quantity demanded unchanged.
It means the knowledge of price elasticity of demand is of much importance for the
businesses.
While income elasticity of demand is the responsiveness of change in quantity demanded
due to change in income. It is calculated by using following formula:
Income elasticity of demand =
The knowledge of income elasticity of demand is also very important for businessman.
Every businessman takes the decisions to produce goods by taking into account the
income elasticity of demand.
In case of boom in the economy, businesses and individuals will be earning high profits.
They have more purchasing power and they will prefer to buy luxurious goods. So,
Producers should produce more luxurious goods in this situation.
While in economic slump, recession and depression people will have lesser purchasing
power and they will tend to by more inferior goods. So, businesses should focus on the
production of such goods during this period.
It shows that the knowledge of income elasticity of demand is of much importance for the
businesses.
But it is very difficult to calculate price elasticity and income elasticity of demand
accurately, because the response of quantity demanded is not only dependent upon price

AS Level Economics Paper 2

and income, it also depends upon many other factors as well. It also keeps on changing
with the passage of time.
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