introduction, importance of the study of elasticity of demand,

1. PRESENTED BY
K.SWATI

3. 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.

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

5. 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.

6. For example:

7. 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.

8. FOR EXAMPLE:

9. 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.

10. 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’.

11. 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.

12. 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.

13. 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.

14. 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.

15. 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.

16. 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.

17. 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.

18. 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.

19. 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.

20. For example: