Importance of Demand Elasticity in Business Economics
Importance of Demand Elasticity in Business Economics. From both theoretical and practical points of view, recognizing the notion of demand elasticity is highly useful in business economics. It is important in the fields of manufacturing, trade, and commerce. It helps to solve managerial issues, especially those related to pricing and production decision-making.
In the following three ways, we will address the definition of demand elasticity:
- Price Elasticity of Demand Managerial Use
- Importance of Demand Elasticity of Profits
- Cross Elasticity of Demand Importance
Managerial applications of market elasticity of prices
The definition of demand elasticity is of great practical significance when it comes to understanding the number of problems and formulating economic policies, such as:
Determination of Price Under Monopoly:
A monopolist takes into account the market elasticity when setting the price for his product (1) when the market for his product is elastic, by setting a low price, he can benefit more. Low price means large sales and, thus, large overall sales If demand is inelastic, high prices can be set. High prices with more or less constant demand (being inelastic) suggest high overall revenues.
Price Discrimination Basis:
It is called price discrimination when a monopolist sells his goods at different prices. The strategy of price discrimination can be implemented by a monopolist because the price elasticity of demand for his commodity is different for different uses and for different customers. It charges high prices for consumers whose demand is inelastic, and low prices for consumers whose demand is elastic.
Pricing of Joint Goods:
The principle of demand elasticity is commonly used in the pricing of joint goods, such as wool and mutton, wheat and straw, cotton and cotton seeds, oil and oil cakes, etc. Separate production costs of each material are not understood in such situations. The price of each one is then set on the basis of its demand elasticity. That is why products such as wool, wheat, and cotton with inelastic demand are highly-priced compared to products such as mutton, straw, and cotton-seeds with elastic demand.
Determination of wages:
In deciding the wages of a specific form of labor, the principle of demand elasticity is essential. If the demand for labor in an industry is elastic, union stakeholders’ strategies would not be of many benefits in raising wages. If, however, the demand for labor is inelastic, even the union’s threat of strike would force the employer to increase workers ‘ salaries in the theory of demand elasticity. If the demand for labor in an industry is elastic, the tactics of the union stakeholders will not be of many benefits in raising wages. If, however, the demand for labor is inelastic, then the threat of a union strike will not be of many benefits.
The advantage for the Minister of Finance:
The idea of demand elasticity is of utmost importance to the Minister of Finance. The Minister of Finance must figure out how to add more money to the exchequer. For this reason, the finance minister takes into account the elasticity of demand when introducing new taxes.
i) Taxes on commodities with elastic demand would produce less revenue. It is because taxes are going to increase their prices and thus push down their demand.
(ii) Goods with inelastic demand are taxed at a higher rate. Less demand means fewer profits. There is no question that the price of goods will increase because of these taxes, but there will be little decrease in their demand. Consequently, the state exchequer would accrue further tax revenue.
Determination of prices of public utilities:
The principle of demand elasticity helps to set prices for services provided by mass consumption services of public utilities such as water, rail and communication electricity post, and telegraph, services. A high price is paid where the demand for services is inelastic, whereas a lower price is paid in the case of elastic demand. This is why HVPN charges household consumers a high electricity rate relative to industrial or agricultural consumers.
Distribution of the burden of taxation:
The principle of demand elasticity is significant in understanding the effect on customers and producers of indirect taxes, such as sales tax, excise duty, etc. If the market for a commodity is inelastic, the indirect tax burden would be higher for customers. The price of the commodity will rise as a result of the tax, but the market will not be inelastic Contract In this situation the pressure on the manufacturers or sellers will be lower. On the other hand, if the market for the commodity is elastic, the indirect tax burden is relatively higher on the manufacturers.
The principle of demand elasticity is also relevant in the international trade market. By raising the price of its exports, a country will benefit if its demand in the importing country is inelastic. If their demand is elastic in the importing country, then the price will be reduced by the exporting country and its overall exports will rise and thus stand to benefit. A nation will be able to import cheaply those items whose demand in the home market is elastic.
The employment effect of automated machines depends on the elasticity of the demand for the products generated by the machines. Staffs are also opposed to the use of automated devices for fear of unemployment. Machines do not always minimize labor demand. It all relies on the price elasticity of demand for their manufacturing. In certain instances, where the cost and prices of products with elastic demand are reduced by machines, the amount requested may increase. As a consequence, it will have to increase production and recruit more workers. Conversely, if output demand is inelastic, robots will replace jobs and generate unemployment.
Foundation of the Devaluation Policy:
Taking into account the elasticity of demand for imports and exports in the case of a country contemplating the correction of its adverse balance of payments by devaluation. Devaluation makes exports cheaper and the adopting country’s imports more costly. The first consequence would be that the prices of our imports would increase as we devalue our currency and we will be induced to lower our imports. However, this relies on the elasticity of demand for imports. The decline in foreign export prices, on the other hand, would lead us to export more, but it would depend on the elasticity of foreigners’ demand for our exports. The degree to which we are able to reduce the difference between our imports and our exports is therefore dependent on the elasticity of demand for exports and imports.
When Awarding Insurance:
The Government takes into account the elasticity of the market for the goods of the industries applying for a subsidy or insurance award. Only those industries whose goods have an elastic demand to earn subsidy or protection. Consequently, unless their prices are reduced by subsidies or through raising the prices of manufactured goods by placing heavy duties on them, they are unable to face international competition.
Paradox of Farmers ‘Poverty:
In fear of bumper harvesting, farmers’ income is lower due to the decrease in the price of their products compared to income in fear when the harvest is very bad. The paradox of suffering in the midst of plenty is called this. It is generally said that a good harvest takes the farmer to poverty. The inelastic nature of the market for the majority of agricultural products easily explains this phenomenon. As their demand is inelastic, agricultural product prices would be low when their supply is higher due to the bumper crop. As a result, their overall yield is reduced; the farmers would thus be the losers.