Importance of the study of elasticity of demand

introduction, importance of the study of elasticity of demand,

1. IMPORTANCE OF THE STUDY OF ELASTICITY OF DEMAND PRESENTED BY K.SWATI

2. introduction The concept of elasticity of demand plays a crucial role in the pricing decisions of the business firms and the Government when it regulates prices. The concept of elasticity is also important in judging the effect of devaluation of a currency on its export earnings. It has also a great use in fiscal policy because the Finance Minister has to keep in view the elasticity of demand when it considers imposing taxes on various commodities. We shall explain below the various uses, applications and importance of the elasticity of demand.

3. Importance of the Study of Elasticity of Demand For the Businessman. For Monopolist. For Finance Minister. For Determination of Prices of Joint Products. For Explaining the Paradox of Poverty in the Midst of Plenty. For Determining Reward of Factors of Production. For Taking over Public Utility Services. For Pricing Policy for Public Utilities. Terms of Trade between two countries. Determination of Rates of Foreign exchange. For Price Control Policy. For Tariff Policy. Incidence of Taxation.

4. 1. For the Businessman A knowledge of the nature of the elasticity of demand for his products will help a businessman to decide whether he should cut his price in a particular case. In general , for items where the demand is elastic , it will pay him to charge relatively low prices , while on those whose demand is inelastic , he would be better off with a higher price.

5. For example:

6. 2. For Monopolist The price elasticity concept is of much significance , particularly to a monopolist who fixes his own prices for his goods. If demand for his goods is inelastic , it will be profitable for him to charge a higher price and sell a smaller output. If demand is elastic , it will be profitable to change a lower price and increase the sales.

7. FOR EXAMPLE:

8. 3. For Finance Minister Whenever the Finance Minister contemplates the introduction of a fresh levy upon certain commodities or the raising of the tax-rates on existing tax objects with a view to getting more of revenue for the state , he makes an intensive study of the elasticity of demand for the commodities in question. The Finance Minister often taxes those commodities whose demand is price-inelastic. This increases taxation revenue.

9. 4. For Determination of Prices of Joint Products The concept of the elasticity of demand is of much use in the pricing of joint products , like cotton and cotton seeds , wool and mutton , wheat and straw , etc. here it is not possible to ascertain separate marginal cost of joint product. The transport authorities fix their rates according to the principle ‘charge what the traffic will bear’.

10. 5. For Explaining the Paradox of Poverty in the Midst of Plenty The concept of elasticity of demand explains the paradox of poverty in the midst of plenty. For example , if there is a bumper crop of wheat it may spell disaster to farmers , instead of causing prosperity , if the demand for wheat is inelastic. A fall in price of wheat due to an increase in supply will reduce the incomes of farmers.

11. 6. For Determining Reward of Factors of Production Elasticity of demand is equally important in determining the rewards of the various factors of production in the country. For instance , if the demand for workers is elastic , efforts of trade unions to raise the wages of the workers will meet with failure. Factors of production which have a more elastic demand have to accept a smaller reward ; and factors which have an inelastic demand can command a bigger reward.

12. 7. For Taking over Public Utility Services State takeover of public utility services can also be explained with the help of elasticity of demand. Demand for public utilities such as electricity and water supply , posts and telegraphs , public transportation , etc. , is generally inelastic in nature. For example , in Bombay City , the bus service in suburban areas was privately run. It was later taken over by the Municipal Corporation of Greater Bombay.

13. 8. For Pricing Policy for Public Utilities Price elasticity is also influential in determining a price policy by public utility undertakings , like electric supply undertakings , railways , etc. such undertakings determine their rates for different uses on the basis of the elasticity of demand and try to cover the losses from one group of users out of the gains reaped from the other groups.

14. 9. Terms of Trade Between two Countries In the international trade , the price elasticity of demand is helpful in ascertaining the ‘terms of trade’. If exports have inelastic demand , a higher price can be charged from abroad. Similarly , if imported goods have elastic demand in the internal market , a lower price is to be fixed. Both these enable a country to have favourable ‘terms of trade’ in respect of international trade.

15. 10. Determination of Rates of Foreign Exchange For determining the rates of foreign exchange for the home currency , the government has to take into account the elasticity of demand for its exports and imports. This will enable the government to know the likely effects of devaluation or revaluation of its currency , in terms of foreign currencies.

16. 11. For Price Control Policy In underdeveloped countries like India , the price control policy can be pursued only after estimating the price elasticity of demand of strategic commodities. Price control is exercised generally in case of commodities having lower degrees of elasticities or inelastic demand.

17. 12. For Tariff Policy Imposition of tariff raises the prices of domestic goods. The extent to which the internal price rise depends on the elasticity of demand of the protected goods. On the contrary , if the demand is less elastic , people will have to bear the burden of higher prices as a result of the tariff policy.

18. 13. Incidence of Taxation Incidence of tax lies on the person who ultimately pays the tax. The incidence is on the buyer , if demand is perfectly inelastic. He will go on buying as much as before despite the price rise. Principle of justice in taxation is thus based on elasticity of demand.

19. For example:

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