BE/U2 Topic 9 Importance of Elasticity of Demand
Price elasticity of demand is a very important concept. Its importance can be realized from the following points:
- International Trade
In order to fix prices of the goods to be exported, it is important to have knowledge about the elasticity’s of demand for such goods.
A country may fix higher prices for the products with inelastic demand. However, if demand for such goods in the importing country is elastic, then the exporting country will have to fix lower prices.
- Formulation of Government Policies
The concept of price elasticity of demand is important for formulating government policies, especially the taxation policy. Government can impose higher taxes on goods with inelastic demand, whereas, low rates of taxes are imposed on commodities with elastic demand.
- Factor Pricing
Price elasticity of demand helps in determining price to be paid to the factors of production. Share of each factor in the national product is determined in proportion to its demand in the productive activity. If demand for a particular factor is inelastic as compared to the other factors, then it will attract more rewards.
- Decisions of Monopolist
A monopolist considers the nature of demand while fixing price of his product. If demand for the product is elastic, then he will fix low price. However, if demand is inelastic, then he is in a position to fix a high price.
- Paradox of poverty amidst plenty
A bumper crop, instead of bringing prosperity to farmers, brings poverty. This is called the paradox of poverty amidst plenty. It happens due to inelastic demand for most of the agricultural products. When supply of crops increases as a result of rich harvest, their prices drastically fall due to inelastic demand. As a result, their total income goes down.