Uses or Importance of Price Elasticity of Demand Uses or Importance of Price Elasticity of Demand

Uses or Importance of Price Elasticity of Demand

Price elasticity of demand has great practical importance in the formulation of economic policies and understanding economic problems.

1. Monopoly price determination: A monopolist while fixing the price of the product has to see whether the demand for the product is elastic or inelastic. If the demand for his product is elastic, he can get more profit by fixing a low price. If the demand for his product is inelastic, he can get more profit by fixing the high price. Thus, a producer under monopoly competition has to study the degree of elasticity of demand in pricing his product.

2. Price determination under discriminating monopoly: Under discriminating monopoly, different prices for the same product are charged in different markets. Low price is charged for the products in the market having elastic demand and high price is charged in the market having inelastic demand.

3. Price determination of public utilities: The concept of price elasticity of demand is very useful to determine the price of public utilities such as postal services, drinking water, electricity, etc. The price of these services should be determined on the basis of the elasticity of demand. If the demand for services is inelastic, a high price is charged. If the demand for service is elastic, a low price is charged.

4. Price determination of joint products: The price elasticity of demand is useful in the pricing of joint products like sheep & wool paddy & straw cotton é& cotton seeds, etc. In such cases, the cost of production of each product cannot be calculated separately. The price of each product should be determined on the basis of the elasticity of demand. The higher price is charged for the product with inelastic demand and the lower price is charged for the product with elastic demand.

5. Wage determination: The concept of price elasticity of demand is important in the determination of wages of a particular type of labor. If the demand for service of labor is inelastic, they can force the employer to increase the wage organizing strike. On the other hand, if demand for service of labor is elastic, strikes and other trade union tactics would not work.

6. International trade: Price elasticity of demand has great practical importance for determining terms of trade, The terms of trade depend upon the relative elasticity of goods exported & imported between the countries. A country gains from international trade if it exports goods having inelastic demand in importing countries and imports goods for which demand is elastic in the domestic market.

7. Importance to finance minister: The concept of price elasticity of demand is of great importance to the finance minister. The finance minister has to find out how he can collect more revenue from the state. The imposition of a higher tax rate on goods with inelastic demand or necessary goods brings more revenue to the government as an increase in price due to tax does not affect demand much. However, a heavy tax on poor people is not socially justifiable. Hence, a low rate of tax should be imposed on necessaries and a high rate of tax should be imposed on luxurious goods.

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