Question

Answer the following Questions. [Any Three] 

Explain the  imprtance of elasticity of demand.

Answer 1

Introduction: - The concept of elasticity of demand has certain important uses. It is important to the business man, government authorities, trade unions, professional and others. The uses are:  

1. Price Fixation: -The knowledge of price elasticity of demand enables the businessmen to fix prices. If the elasticity of demand is relatively inelastic such as in the case of luxury watches, the businessmen may fix a higher price. However, if the elasticity of demand is relatively elastic, the producer cannot fix higher prices.
2. Collective Bargaining: -The knowledge of price elasticity of demand is helpful to trade unions in collective bargaining in respect of wage fixation and other incentives to workers. They may ask the management to pay higher wages to the workers by changing the price policy of their products.
3. Formulation of Tax policy: -The Central and State government may use the knowledge of price elasticity of demand top frames tax policy relating to goods and services. The government may increase taxes on those products, which have inelastic demand. (e.g. cigarettes) for instance in the case of perfectly inelastic demand products (food for survival, clothes, salt etc) consumers will buy the products irrespective of the tax rate.
4. Formulation of foreign Trade Policy: -The government may use the price elasticity of demand for framing foreign trade policy. Generally, the foreign Trade policy may try to encourage exports. And to a certain extent discourage imports.
5. Factor Pricing: -Knowledge of price elasticity of demand is useful to fix prices of the factors of production. The factors whose demand is relatively inelastic command a higher price, and those factors whose demand is relatively elastic command a lower price.
6. Promotion: -Knowledge of price elasticity of demand is useful to businessmen in promoting their products. They may not spend on promotion on those products, whose demand is relatively inelastic. However, they may spend heavily on promotion on those products, whose demand is relatively elastic. (free gifts)