Question: Explain the usefulness of PED and YED concepts to a producer in trying to maximize revenue.
Price Elasticity of Demand (PED) refers to the degree of responsiveness of quantity demanded when there is a given change in the price of a product.
Income Elasticity of Demand (YED) refers to the degree of responsiveness of quantity demanded when there is a given change in the income of consumer.
PED can serve as a pricing policy, telling producer how to change prices to increase revenue.
If the demand of an item is price elastic, firms should decrease price to increase revenue.
This is because when there is a drop in price, the increase in quantity demanded is more than proportionate. Hence the producer is likely to gain more revenue since more people are buying, even though the price is slightly lower. This is usually relevant to producers selling luxury goods like branded bags and clothes, because these items are non necessity. Consumers are likely to buy them if there are drop in prices.
If the demand of an item is price inelastic, firms should increase price to increase revenue.
This is because when there is a rise in price, the increase in quantity demanded is more than proportionate. Hence the producer is likely to gain more revenue since more people are buying, even though the price is increase. This is usually relevant to producers selling basic necessities like food and water, because these items are necessity. Consumers are likely to buy them if there are increase in prices.
Price Elasticity Diagram
YED is helpful as a production policy. It tells producers what to produce when there are given changes in consumers’ income. When a country goes through economic growth, consumers incomes are increasing.
According to theory, there is a greater than proportionate rise in demand for luxury items, like branded bags and cars. The producers should quickly increase production of this item. This is because the rise in demand is more than proportionate to the rise in income.
The demand for basic goods will also go up, but this rise in less than proportionate to the rise income. Producers can increase production but the rise in demand is small. This usually applies to items like food.
At the same time, producers are likely to see a drop in the demand for inferior goods. This is usually items like cheap food, instant noodles, unhealthy snacks. Consumers will purchase less of these items when there is a rise in income.
But, there are limitations. PED only works at a given period of time because the demand of consumers change over time. The producers also do not have ability to change prices as and when they like to.
YED will change for different consumers, it is not possible to measure the change in consumers’ income individually.
Join our Economics tuition classes or view more resources.
Contact us now and join us for a free trial!
