BUSSINESS ECONOMIC PROJECT

May 2, 2012

PROJECT INCOME ELASTICITY OF DEMAND

SUBMITTED BY:
M. Faizan Saleem Reg Ovais Moin Reg Shadab Khan Reg

INSTRUCTOR:
Dr. Alam Raza

DATE OF SUBMISSION :
2012

BUSSINESS ECONOMIC PROJECT

May 2, 2012

ACKNOWLEDGEMENTS

First we would like to acknowledge our parents. Without them none of our accomplishments in life would be possible. We want to thank them for being good role models and for helping to teach us the skills necessary to be successful in life. We also want to thank them for their support. We also want to thank our advisors throughout the months Dr.

Alam Raza . Teacher has

taught us what it means to be a great teacher, academic, and scholar, for her patience and tireless effort. Her hard work and dedication, for the past four months, are two major reasons why this accomplishment has been made possible. In addition, we would like to thank them for their advice towards teaching and research, Their words will be with us for the whole of our careers. Finally, we want to thank the friends who have helped us to enjoy ourselves along the way. This report is a journey and we will forever appreciate those of you who have helped us to have fun with the process. Thanks for offering alternative perspectives and for pushing us in the right direction.

BUSSINESS ECONOMIC PROJECT

May 2, 2012

INTRODUCTION
Elasticity Of Demand : The elasticity of demand measures the responsiveness of demand to changes in a factor that affects demand. Elasticity can be estimated for price, income, prices of related products, and advertising expenditures. The own-price elasticity is the ratio of the percentage change in quantity demanded to the percentage change in price, and is a negative number. Demand is price elastic if a 1% increase in price leads to more than a 1% drop in quantity demanded, and inelastic if it leads to less than a 1% drop in quantity demanded. The own-price elasticity can be used to forecast the effects of price changes on quantity demanded and buyer expenditure. Elasticity can be used to forecast the effects on demand of simultaneous changes in multiple factors. elasticity varies with adjustment time. The long-run demand is generally more elastic than the short-run demand in the case of nondurables, but not necessarily for durables. Elasticity can be estimated from records of past experience or test markets by the statistical technique of multiple regressions.

TYPES OF ELASTICITY OF DEMAND

We may distinguish between the tree types of elasticitys, 1. Price Elasticity 2. Income Elasticity 3. Cross Elasticity Price Elasticity : Price elasticity of demand is the quantitative measure of consumer behavior that indicates the quantity of demand of a product or service depending on its increase or decrease in price. Price elasticity of demand can be calculated by the percent change in the quantity demanded by the percent change in price. Price elasticity of demand is determined by the price of the item or service, availability of alternative goods, amount of time being measured, consumer income and whether the item or service is considered to be a necessity or a luxury.
Price Elasticity = Proportionate change in amount demanded Proportionate change in price

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The factors that affect the price elasticity of demand for a particular good are: S - substitutes P proportion of income L - luxury or necessity A - addictive T time Income Elasticity : Income Elasticity is a measure of responsiveness of potential buyers to change in income. It shows how the quantity demanded will change when the income of the purchaser changes, the price of the commodity remaining the same. It may be defined thus: The Income Elasticity of demand for a good is the ratio of the percentage change in the amount spent on the commodity to a percentage change in the consumers income, price of commodity remaining constant. Thus,
Income Elasticity = Proportionate change in the quantity purchased Proportionate change in Income

while prices remain constant. CROSS ELASTICITY Here, a change in the price of one good causes a change in the demand for another. Cross elasticity of Demand for X and Y
Cross Elasticity = Proportionate change in purchases of commodity X Proportionate change in the price of commodity Y

This type of elasticity arises in the case of inter-related goods such as substitutes and complementary goods. The two commodities will be complementary, if a fall in the price of Y increases the demand for X and conversely, if a rise in the price of one commodity decreases the demand for the other. They will be substitute or rival goods if a reduction in the price of Y decreases the demand for X, and also if a rise in price of one commodity (say tea) increases the demand for the other commodity (say coffee). The cross elasticity of complementary goods is positive and that between substitutes, it is negative.

BUSSINESS ECONOMIC PROJECT Ranges Of Elasticity : 1. 2. 3. 4. 5. Perfectly Elastic Perfectly Inelastic Unit Elastic Relatively Elastic Relatively Inelastic

May 2, 2012

Perfectly Elastic :
Quantity demanded does not respond to price changes. (Elasticity equals infinity)

Perfectly Inelastic : Quantity demanded changes infinitely with any change in price. (Elasticity equals 0)

BUSSINESS ECONOMIC PROJECT

May 2, 2012

Unit Elastic : Quantity demanded changes by the same percentage as the price. (Elasticity equals 1)

Relatively Elastic : Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one. (Elasticity is -1)

BUSSINESS ECONOMIC PROJECT

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Relatively Inelastic : Quantity demanded responds strongly to changes in price. Price elasticity of demand is greater than one. ( Elasticity is 1+ )

BUSSINESS ECONOMIC PROJECT

May 2, 2012

SUMMARY
Income Elasticity Of Demand :
The degree to which a demand for a good changes with respect to a change in income depends on whether the good is a necessity or a luxury. The demand for necessities will increase with income, but at a slower rate. This is because consumers, instead of buying more of only the necessity, will want to use their increased income to buy more of a luxury. During a period of increasing income, demand for luxury products tends to increase at a higher rate than the demand for necessities. A measure of the relationship between a change in income and a change in quantity of a good demanded:

Income Elasticity =

Proportionate change in the quantity purchased Proportionate change in Income

Or

Normal goods have a positive income elasticity of demand so as income rise more is demand at each price level. We make a distinction between normal necessities and normal luxuries (both have a positive coefficient of income elasticity). Necessities have an income elasticity of demand of between 0 and +1. Demand rises with income, but less than proportionately. Often this is because we have a limited need to consume additional quantities of necessary goods as our real living standards rise. The class examples of this would be the demand for fresh vegetables, toothpaste and newspapers. Demand is not very sensitive at all to fluctuations in income in this sense total market demand is relatively stable following changes in the wider economic (business) cycle.

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May 2, 2012

Luxuries on the other hand are said to have an income elasticity of demand > +1. (Demand rises more than proportionate to a change in income). Luxuries are items we can (and often do) manage to do without during periods of below average income and falling consumer confidence. When incomes are rising strongly and consumers have the confidence to go ahead with big-ticket items of spending, so the demand for luxury goods will grow. Conversely in a recession or economic slowdown, these items of discretionary spending might be the first victims of decisions by consumers to rein in their spending and rebuild savings and household financial balance sheets. Many luxury goods also deserve the sobriquet of positional goods. These are products where the consumer derives satisfaction (and utility) not just from consuming the good or service itself, but also from being seen to be a consumer by others. Inferior Goods Inferior goods have a negative income elasticity of demand. Demand falls as income rises. In a recession the demand for inferior products might actually grow (depending on the severity of any change in income and also the absolute co-efficient of income elasticity of demand). For example if we find that the income elasticity of demand for cigarettes is -0.3, then a 5% fall in the average real incomes of consumers might lead to a 1.5% fall in the total demand for cigarettes (ceteris paribus).

Within a given market, the income elasticity of demand for various products can vary and of course the perception of a product must differ from consumer to consumer. The hugely important market for overseas holidays is a great example to develop further in this respect. What to some people is a necessity might be a luxury to others. For many products, the final income elasticity of demand might be close to zero, in other words there is a

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very weak link at best between fluctuations in income and spending decisions. In this case the real income effect arising from a fall in prices is likely to be relatively small. Most of the impact on demand following a change in price will be due to changes in the relative prices of substitute goods and services.

The income elasticity of demand for a product will also change over time the vast majority of products have a finite life-cycle. Consumer perceptions of the value and desirability of a good or service will be influenced not just by their own experiences of consuming it (and the feedback from other purchasers) but also the appearance of new products onto the market. Consider the income elasticity of demand for flatscreen color televisions as the market for plasma screens develops and the income elasticity of demand for TV services provided through satellite dishes set against the growing availability and falling cost (in nominal and real terms) and integrated digital television.

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METHODOLOGY
To observe the income elasticity effect on the demand the procedure we have gone through in this report is first to make the questioner relates with the consumer income and their expenditures .To do so we have asked the people to make choices between normal, inferior and luxurious goods when their income changes to answer the questions .As the matter of fact the audience we have are mostly student so we also asked that how a student would react when their pocket money will change. After collecting the views from the different type of people now we are able to analyses that how someone is going to act when their income will change .

DATA COLLECTION
Total 20 Questioner has been worked on through which 10 has been filled up by male and 10 by female. And results are as follows :

Gender

Male (10)

Female (10)

Q#1 Currently job status.

Student Employed Self Employed

4 5 1

Student Employed Self Employed

8 2

Q#2 Are you a drug or alcoholic user or have any kind of addiction(smoking, etc.) ?

Yes

No

Yes

No

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BUSSINESS ECONOMIC PROJECT

May 2, 2012

Male (10) Q#3 Monthly Income Or Pocket money : 5,000 or less 5,000 15,000 15,000 - 25,000 25,000 or Above Q#4 Total monthly expense on transportation & extra meal ?

Female (10)

2 4 3 1

5,000 or less 5,000 15,000 15,000 - 25,000 25,000 or Above

2 6 2

2,000 - 5,000 5,000 - 8,000 8,000 - 12,000 12000 Or More

1 6 3

2,000 - 5,000 5,000 - 8,000 8,000 - 12,000 12000 Or More

7 3

Q#5 If you get 10% Off on all luxurious items then would u go for it ? Yes Q#6 Now if your monthly income or Pocket money reduce by 10% & there is 20% Off on luxurious item , Would you go for it ? Yes Q#7 Would you cut off the continuous use of your addiction or drugs If your monthly income or Pocket money reduce ?

10

No

Yes

10

No

No

Yes

No

Yes

No

Yes

No 9

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BUSSINESS ECONOMIC PROJECT

May 2, 2012

Male (10) Go for the cheaper Q#8 In case of some reduction in your monthly income or pocket money , what would be your act ? Item .

Female (10) Go for the cheaper

Item .

Cut off the usage of Normally consumption Item . Cut off the usage of Normally consumption Item & go for the cheaper one .

Cut off the usage of Normally consumption Item . Cut off the usage of Normally consumption Item & go for the cheaper one .

Keep on using Normally consumption Item .

Keep on using Normally consumption Item .

Q#9 If your monthly income or Pocket money remains unchanged would u prefer to buy cheaper goods?

Yes Yes

No

No

Q#10 If your monthly income or Pocket money rises then what would be your act ?

Stick with the item you are using . Switch to the Up Graded one.

Stick with the item you are using . Switch to the Up

2 8

3 6

Graded one.

Started buying cheaper item in bundle. Started hoarding.

Started buying cheaper item in bundle. Started hoarding.

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BUSSINESS ECONOMIC PROJECT

May 2, 2012

DATA ANALYSES

After getting the data from the questioner now we can analyze it: As on above we have asked in Q#5 if you get 10% Off on all luxurious items then would u go for it & there is no change in income. Every one answer that they will go for it , so as we know when the price of any luxurious item goes down its quantity demanded become infinitive. Then in Q#6 we decreased the income , but still people are willing to buy the luxurious Item. So we can say no effect on the perfectly elastic item if our income decreases or rises.

Then in Q#7 Would you cut off the continuous use of your addiction or drug If your monthly income or Pocket money reduces ? Here , the drugs or any kind of addictions are count in Perfectly Inelastic item , the result we got is yes in almost every answer .whether their income goes down or high , people will contentiously use it .

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BUSSINESS ECONOMIC PROJECT

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Whether the price of the good goes up or down or Income goes up or down its quantity demanded remain unchanged because it is perfectly inelastic.

Now in Q#8 In case of some reduction in your monthly income or pocket money , what would be your act . the mostly answer we get is that they will go for the cheaper goods, so alternatively there will be reduction in the demand of normal goods.

There will be shift inside of the demand curve of normal goods if the income decreases.

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BUSSINESS ECONOMIC PROJECT

May 2, 2012

There will be a upward shift in demand curve of cheaper goods if the income decreases.

Now in Q#9 If your monthly income or Pocket money remains unchanged would u

prefer to buy cheaper goods? The answer we got is mostly In No ,so there will be no effect neither on cheaper goods or nor the normal goods. Those who can afford the normal they keep on using the normal , & those who buy the cheaper they will continue to buy the cheaper. So Here ,

Here dx shows the demand of inferior goods and dy shows the demand of normal goods.

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BUSSINESS ECONOMIC PROJECT

May 2, 2012

In Q#10 If your monthly income or Pocket money rises then what would be your act ? Here, Mostly people answer that they will shift to the upgraded one because the goods they were using before became cheaper or inferior for them. But in normal situation we desire more the item we were using.

In the above graph the goods they were using before the increase in income now became inferior for them,

Now in the above graph the upgraded goods become the normal goods for them as there income increases. Or in normal we desire more the item we were using before .

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BUSSINESS ECONOMIC PROJECT

May 2, 2012

CONCLUSION

Income elasticity of demand is used to see how sensitive the demand for a good is to an income change. The higher the income elasticity, the more sensitive demand for a good is to income changes. A very high income elasticity suggests that when a consumer's income goes up, consumers will buy a great deal more of that good. A very low price elasticity implies just the opposite, that changes in a consumer's income has little influence on demand.

When the consumers income increases, assuming that prices remain constant, The capacity of the consumer to purchase that good increases. We say that the real income of the consumer has increased. When the real income increases does the consumer buy more of this commodity. In reality the consumer does not buy more of all the goods. In some cases the demand increases, in some cases it decreases and in still other cases it remains the same. The measure of income elasticity of demand provides us the answer to these questions. It helps us understand the nature of the commodity and how it is perceived by the consumer.

Income elasticity, are valuable aids in the measurement of demand for different commodities. As such they are also helpful in measuring the incidence of taxation.

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BUSSINESS ECONOMIC PROJECT

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REFERENCES

http://en.wikipedia.org/wiki/Income_elasticity_of_demand

http://tutor2u.net/economics/revision-notes/as-markets-income-elasticity-of-demand.html

http://www.slideshare.net/binuja_shrestha/elasticity-4895981

http://www.amosweb.com/cgibin/awb_nav.pl?s=wpd&c=dsp&k=income+elasticity+of+demand

http://economics.about.com/cs/micfrohelp/a/income_elast.htm

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