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The concept of price elasticity of demand plays an important role in the functioning economies by having a significant contribution in the field of industry, trade, and commerce. Not only this, it helps organisations in analysing economic problems and making appropriate business decisions. The figure, shows the importance of price elasticity of demand:
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Importance of Price Elasticity of Demand
Let us discuss the importance of price elasticity of demand in detail.
- Price determination
- Price discrimination
- Formulation of taxation policies
- International trade
- Formulation of agricultural policies
The concept of price elasticity of demand is used by organisations in determining prices under various situations.
For instance, under monopolistic market conditions, an organisation sets a low price per unit of the product in case of elastic demand. As a result, the demand for the product rises. On the other hand, when the demand for the product is inelastic, the price is set very high. This helps in generating large revenues for organisations due to the high price of a product while demand remains constant.
This is another area where price elasticity of demand plays an important role. Price discrimination refers to charging different prices from various customers for the same product.
The common example of price variation is petrol. Its demand is inelastic as the change in the price does not affect consumption. Thus, the price of petrol is charged differently in different states of India.
Formulation of taxation policies
The government takes under consideration the price elasticity of demand before formulating taxation policies. Generally, government levies high taxes on products (for producers) whose demand is elastic. On the contrary, it levies high taxes on products (for customers) having inelastic demand as the consumption remains unaffected.
The concept of price elasticity has a significant role in international trade. This is because successful trade transactions between the two countries are dependent on the price elasticity of demand. This is because the price elasticity of demand is used in deciding the level of imports and exports.
For instance, if the demand for the product is inelastic in the international market, the seller country will have an upper hand in exports.
Formulation of agricultural policies
The price elasticity of demand also helps the government in formulating agricultural policies by providing insight into the paradox of poverty. The prices of farm products whose demand is inelastic fall due to large supplies as a result of bumper crops. This results in a fall in prices, which leads to low income for farmers.
Consequently, poverty among farmers increases. Thus, government sets a minimum suitable price for inelastic farm products so that farmers can generate adequate revenues.
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