Importance of Elasticity of Demand

Importance of Elasticity of Demand :

The concept of elasticity of demand is of great importance to producers, farmers, workers and the Government. Lord Keynes considered this concept to be the most important contribution of Alfred Marshall. Significance of the concept becomes clear from the following applications :

1) Importance to a Producer :

Every producer has to decide the price of his product at which he has to sell it. For this purpose, elasticity of demand becomes important. If the demand for a product is relatively inelastic, he will fix up a higher price and vice-versa. The concept of elasticity of demand is also useful to a monopolist to practice price discrimination.

2) Importance to Government :

Taxation policy of the Government is based on the concept of elasticity of demand. Those commodities whose demand is relatively inelastic will be taxed more because it will not affect their demand much and vice-versa.

3) Important in Factor Pricing :

The concept of elasticity of demand is useful in determination of factor prices. The factor of production for which demand is relatively inelastic can command a higher price as compared to those having elastic higher wages, if the demand for the product produced by them is relatively inelastic.

4) Importance in Foreign Trade :

The concept of elasticity of demand is useful to determine terms and conditions in foreign trade. The countries exporting commodities for which demand is relatively inelastic can raise their prices. For example, Organization of Petroleum Exporting Countries (OPEC) have increased the price of oil several times. The concept is also useful in formulating export and import policy of a country.

5) Public Utilities :

In case of public utilities like railways which have an inelastic demand, Government can either subsidise or nationalise them to avoid consumers exploitation.