**6.4. Brand loyalty and changing demand elasticity**

While price elasticity of demand increases as part of macrovariables, this increase in elasticity requires different precautions to be taken, since it would negatively influence profit maximization goal. One of the fundamental elements for the firms to obtain their profit maximization goal is to be able to increase total revenue with price increases they gathered by decreasing substitutability opportunities and price elasticity of demand for their products [24]. Within this scope, primary methods for dropping price elasticity of demand for the firms' products at microlevel are creating or strengthening brand loyalty.

According to Palumbo and Herbig [36], brand loyalty, which has different definitions in literature, is in the most general sense a situation, in which consumers continuously tend to seek and purchase only a certain brand even when competitor businesses offer lower prices and sales promotions.

price changes. Thus, they can increase their total revenues by raising product prices [24]. Yet, together with the increased competition, efficiencies [25, 26] increase, and together with liber-

Especially, liberalization in commerce influences export and import performances of industries, declines in tariffs cause scale increases [28], and thus, competition escalates [29]. As supported by quite a few studies, high protectionism in commerce leads firms to produce under

Commercial liberalization on the other hand allows the tariff structure to soften, large-scale firms to rise together with the increase in competition, and output levels of small-scale firms to rise [29]. Diversity increased in the market structure that grew by this means enhances the substitution opportunity between goods and thereby increases price elasticity of demand. By this way, the scale that increased through liberalization and competition raises diversity of goods and services and therefore their substitutability and serves for the increase of price

In one of the first studies investigating the relationship between market size and innovation, Griliches [31] put forward in 1957 the existence of a significant relationship between technological change and technological adaptation and profitability and market size. In other studies analyzing different sectors following this study, a significant relationship between market size and innovation and innovation elasticity was exhibited [32–34]. In this context, the innovation process, which improves as market size grows, increases price elasticity of demand by

In the light of these analyses, macroeconomic variables, such as short and long term structures, commerce liberalization and competition, market size, and innovation, affect and change the price elasticity of demand for luxury and necessity goods. This change generally reveals itself as the increase of price elasticity of demand for goods. This macrochange of demand elasticity in both luxury and necessity goods composes a risk for firms in microterms. On the other hand against this risk, firms try to decrease the demand elasticity for their products by creat-

Brand loyalty decreases the sensitivity of consumers to the prices of products especially in product groups such as technological products and automobiles. At this point, it is useful to mention about brand loyalty as a microvariable effective on price elasticity of demand.

While price elasticity of demand increases as part of macrovariables, this increase in elasticity requires different precautions to be taken, since it would negatively influence profit maximization goal. One of the fundamental elements for the firms to obtain their profit maximization goal is to be able to increase total revenue with price increases they gathered by decreasing substitutability opportunities and price elasticity of demand for their products [24]. Within this scope, primary methods for dropping price elasticity of demand for the firms' products

optimal scale, and output increases to be negatively affected [30].

elasticity of demand of all necessity and luxury goods.

supporting the increase of product range [35].

ing brands and increasing loyalty to these brands [8].

**6.4. Brand loyalty and changing demand elasticity**

at microlevel are creating or strengthening brand loyalty.

**6.3. Market size, innovation, and changing demand elasticity**

alization, market size [27] increases.

132 Taxes and Taxation Trends

Brand loyalty to be also high in high-priced products [37] leads the consumer, whose brand loyalty increased, to be less sensitive to price changes. Firms, with a purpose of increasing market share and profitability, try to reduce the vulnerability of their products against substitution opportunities and price changes by raising loyalty to their brands. Within this framework, a close relationship between market share and purchase possibilities of brand loyal consumers, who do not respond to price changes, is in question [38].

Brand loyalty provides some advantages to firms against competition. These advantages can be listed as follows:


All these advantages enabled by brand loyalty on the other hand serve price elasticity of demand for the product to fall.

Brand loyalty with regard to Ramsey taxation has importance especially in terms of decreasing price elasticity of demand for luxury goods. Brand loyalty to be high especially in luxury goods [40] drops price elasticity of demand to the so-called goods by weakening substitution possibilities and thus weakens the sensitivity of consumers of luxury goods the price changes of these goods.

All these macrovariables and microvariables change price elasticity of demand for luxury and necessity goods as part of differential tax rates in optimal commodity taxes. Additionally, they give way to Ramsey's inverse elasticity rule to be re-evaluated as part of criticisms it receives about income distribution. At this point, price elasticity of demand for luxury and necessity goods rises depending on short and long term effect, commercial liberalization, and increased competition and innovation, which are all macroeconomic variables.

Thus, demand elasticity of necessity goods, which have a large share in the consumption spending of lower level income groups, increases as part inverse elasticity rule; and therefore, tax rates decrease in line with the increase in elasticity. A decline in the tax rate, which the lower income level group will be exposed to as part of inverse elasticity rule, may create a more agreeable result in income distribution.

The influence microvariables have on price elasticity of demand on the other hand is important especially for luxury goods. Firms, aiming to increase their total revenues by reducing demand elasticity for their products, have the purpose of decreasing the vulnerability of their products against price changes. Since brand loyalty, which is one of the primary microvariables firms use within this framework, is high especially in luxury goods as mentioned above, it affects price elasticity of demand for the goods.

results oppose redistribution policies of the state because of equality-efficiency dilemma. The main starting point on this topic is not being able to enable a certain budget revenue goal via lump-sum taxes because of the asymmetrical information between state and individual and the need for distortionary taxes. In this context, one of the propositions for resolution in the literature

Optimal Taxation of Consumption in the Scope of Changing Elasticities of Demand...

http://dx.doi.org/10.5772/intechopen.74378

135

In optimal tax application with the aim of efficiency, discussion of single rate or differential

Ramsey's study on optimal commodity taxes, which suggest goods to be taxed inversely proportional with price elasticity of demand, is one of the primary studies in the literature. While Ramsey rule basically proposes goods with low price elasticity of demand to be taxed at higher rates, its purpose is to preserve individuals' decisions about the consumption of goods with increasing prices unchanged as part of low elasticity, or in other words, a deadweight loss or wealth loss not to be formed in the economy. This rule, in which economic efficiency concern dominates, faces the biggest criticism because of the unjust distribution emerging as a result of the assumption that all individuals resemble

With the inverse elasticity rule, Ramsey suggests necessity goods, which occupy a large share in the consumption basket of lower income groups, to be taxed at higher rates and goods, which appeal to higher income groups, to be taxed at lower rates due to demand elasticity. What is important in this context is whether price elasticity of demand for goods change or

Price elasticity of demand for luxury and necessity goods rises depending on short and long term effect, commercial liberalization, and increased competition and innovation, which are all macroeconomic variables. On the other hand, since brand loyalty, which is the leading microeconomic variable, is high especially for luxury goods, it affects price elasticity of

Additionally, luxury goods to be taxed at higher rates under the assumption that they are leisure complementaries may affect the decisions of individuals on behalf of working. In this context, the criticisms brought about by Ramsey's rule in terms of economic efficiency at the differential taxation, it can be seen that the rule of inverse elasticity on equality can be

Departmant of Public Finance, Faculty of Economics and Administrative Sciences,

is optimal commodity tax application.

not as part of macrovariables and microvariables.

Address all correspondence to: denizaytac@htit.edu.tr

demand for the aforementioned goods.

tax application is in question.

each other.

reconsidered.

Deniz Aytaç

**Author details**

Hitit University, Çorum, Turkey

Created brand loyalty prevents change in consumer preferences by reducing substitution possibilities of luxury goods and decreasing price elasticity of demand. By this way, in a tax that will be applied as part of inverse elasticity rule, luxury goods will be subject to high-rate taxes because of low demand elasticity. And therefore since aforementioned goods share in the consumption basket is very low for lower level income groups and high for higher level income groups, effect of this taxation, which is applied by considering elasticity, might be positive on income distribution.

Within this scope, while justice in income distribution is served on one hand, a certain budget revenue of optimal taxation goal is achieved through taxing goods with low demand elasticity at a high rate, and this goal is achieved without damaging any economic decisions or in other words without spoiling economic efficiency. Both inverse elasticity rule and leisure complementary goods, which will change preferences of consumers between working and leisure in favor of working, to be taxed at higher rates play a role. The fact that luxury goods are mostly substitutes of leisure lead to this conclusion.

Beginning from this century, labor market and accordingly preferences between leisure and working started to change. In this context, leisure industry has boomed. In many societies, leisure was equalized with luxury goods such as motor sports and traveling and became a symbol of postmodernity [41].

Thus, luxury goods have been effective in the change of the decision for working as a complementary of leisure. While luxury goods with a declined price elasticity of demand as part of brand loyalty are taxed at a higher rate with regard to inverse elasticity rule; at the same time, preferences of individuals in favor of working were strengthened by imposing taxes on leisure complementary goods and thus raising the cost of leisure.

Keeping in mind that criticisms Atkinson and Stiglitz [42, 43] made with regard to differential consumption taxes in terms of economic efficiency, the assumption that the single rate consumption tax will result efficiently in terms of optimal taxation, and under the agreement that other assumptions of Ramsey rule remain the same, demand elasticity of necessity and luxury goods, which changed with the influence of macrovariables and microvariables, will be able to serve in enabling the aimed public revenue without contradicting justice in income distribution under inverse elasticity rule.
