Elasticity of Demand and Its Practical Importance
Elasticity of demand and its practical importance
The concept of elasticity of demand is not merely an abstract idea and of academic interest. Its practical importance is very great.
(i) The concept of elasticity of demand is made practical use of by the Finance Minister and the monopolist. When the Government imposes a tax on a commodity, its price will tend to rise. But if the demand is very elastic, it will considerably fall when the price has risen. The result will be that Government will not get larger revenue from this tax because the people will have considerably curtailed their demand for it. If the Finance Minister, therefore, wants to be certain of the revenue from a particular tax he must levy it on such commodities for which the demand is less elastic. However, because such commodities happen to be necessaries of life, the Finance Minister may like to exempt them or levy a lower tax on such commodities on humanitarian grounds.
(ii) The businessman also takes his cue from the nature of demand while fixing his price. In case the demand is elastic, he will be able to increase his sales by lowering its price and thus gain on the turnover. On the other hand, if the demand is inelastic he knows that the people must buy such commodities. He will be in a position generally to charge a higher price, unless, of course, he has some consideration for human welfare.
(iii) The concept of elasticity of demand is of special value to the monopolist. He is in a position to control the price and he will fix the price in such a manner as to maximize his profit. A high price when the demand is inelastic and a low price when it is elastic will bring him the maximum profit.
(iv) When a monopolist indulges in price discrimination, he fixes the prices in different markets on the basis of elasticity of demand in each market. It is profitable for a discriminating monopolist to fix a low price in the elastic demand market and a high price in the market with less elastic demand.
(v) The concept of elasticity of demand also finds application in the case of joint products. In such a case separate costs are not ascertainable. Hence the producer will be mostly guided by the nature of demand while fixing prices. He will act on the principle: "Charge what the traffic will bear."
(vi) The concept of elasticity is also of great importance to the government when it has to decide as to which particular industries should be declared as public utilities. Those industries for whose products the demand is inelastic and which are controlled by private monopoly should be taken over by the government and treated as public utilities.
(vii) The concept of elasticity influences the determination of wages of a particular type of labour. If the demand for a particular type of labour is inelastic, the trade unions can easily get their wages raised. On the other hand, if the demand for labour is relatively elastic, trade union actions may not be successful in raising wages.
(viii) The knowledge of elasticity also provides guidelines for the advertisement expenditure to be incurred by the producers. The advertisements make the demand for their goods less elastic and hence they are prompted to spend huge sums of money on advertisements for their products.
(ix) The concept of elasticity of demand is a myth tool in international trade. It is used in the calculation of terms of trade. Moreover, when a country is faced with an adverse balance of payments, the government has to consider the elasticities of demand for the country's exports and imports before devaluing its currency.