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Examine, with relevant examples, how American car producers might use the price (PED) and income elasticity of demand (YED) concepts to help determine their pricing and output decisions. [15]


This economics essay applies concepts of elasticity to the car market, using real world examples from the USA. Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its price, ceteris paribus. It is calculated by taking the percentage change in quantity demanded of a good over the percentage change in price. Income elasticity of demand measures the responsiveness the demand for a good to a change in income, ceteris paribus. It is calculated by taking the percentage change in the demand of a good over a percentage change in income. 

After having defined the two main economic concepts, this essay seeks to explain how they can be used to determine pricing and output decisions with the aid of diagrams before linking them to various car producers and finally evaluating the usefulness of these concepts.

[Insert diagram on price elastic demand showing the loss and gain in revenue when price falls]

With the aim of maximizing total revenue in mind, with a fall in price in a price elastic demand, the firm would gain an area bigger than the area loss. This shows that the quantity demanded will increase more than proportionately, resulting in an increase in total revenue earned by the firm.

[Insert diagram on price inelastic demand showing the loss and gain in revenue when price rise]

Likewise, with the same goal in mind, a rise in the price of a good with an inelastic demand would result in the firm gaining an area bigger than the area loss. This indicates that the quantity demanded will fall less than proportionately, also leading to an increase in total revenue. Hence, by knowing the price elasticity of demand for their goods, the firm would know when to raise or cut prices for its benefit in earning maximum total revenue.

For income elasticity of demand, with regard to positive income elasticity, with an increase in income, the demand rises for the normal good and firms should produce more of them when the country faces strong economic growth. As for negative income elasticity, with an decrease in income the demand rises for the inferior good and firms should produce more when the country is having a recession. With a higher magnitude, the extent of the change in demand increases and the firm should be more responsive in terms of the quantity supplied.

When linking these concepts to various car producers, for price elasticity of demand, the bigger firms such as Ford and Chrysler, experience greater price inelasticity for their cars as they are more luxurious and expensive. For the smaller vehicle firms in the USA whose goods are price elastic, they can reduce this extent through extensive advertising and product differentiation.

For income elasticity of demand, cars might be considered to be as normal goods as they offer more convenience and comfort as compared to taking public transport where it is likely to be more crowded and people have less personal space. In addition, some car companies produce cars of better quality and have established brand loyalty amongst consumers. For these car producers, the income elasticity of their cars is more elastic.

In particular, Ford cars can generally be considered normal goods, and more of these should be produced in a good economic climate. However, if Ford really wants to earn much more, it should produce more of its luxury series, the Lincoln (Lincoln Motor Co. produces what can be considered a luxury American car). However, if Ford produces cheaper, simpler cars, this would only be an effective strategy in an economic downturn because the cheaper, simpler models could arguably be considered inferior goods (relative to the normal and normal luxury goods that Ford produces). 

In conclusion, while evaluating the usefulness of these concepts, price elasticity of demand may not be that effective as the cost involved in production has to be factored in for the car companies to truly earn profits and not merely rely on the demand for them. As for income elasticity of demand, it may not be that useful either as data was taken from past statistics and thus may not be very accurate for today as the economy would have changed.

JC Economics Essays - economics tutor's comments: This part (b) economics essay did make an attempt to answer the economics question posed and in fact used a few American car examples, which is good. It is always a good idea to answer the question directly in Economics examinations. However, this economics paper could have done much better had it given more analysis both in theory and also using more real world examples of American car companies. Overall, it did a good job. Special thanks to A G and T students; the essay was written under examination conditions but has been edited for blog posting. 

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