What is the importance of Price Elasticity of Demand?

Importance of Price Elasticity of Demand:

1. Business decisions : The concept of price elasticity of demand helps the firm to decide whether or not to increase the price of their product. Only if the product is inelastic in nature, then raising of price will be beneficial. On other hand, if the product is elastic in nature, then a rise in price might lead to considerable fall in demand. Therefore the price of different commodities are determined on the basis of relative elasticity.

2. To monopolist : A monopolist often practices price discrimination. Price discrimination is a process in which a single seller sells the same commodity in two different markets at two different prices at the same time. The knowledge of price elasticity of the product to the monopolist is important because he would charge higher price from those consumers who have inelastic demand and lower price from those consumers who have elastic demand.

3. Determination of Factor Price : The concept of elasticity of demand also helps in determining the price of various factors of production. Factor having inelastic demand gets higher price and factors having elastic demand gets lower price.

4. Route for International Trade : If demand for exports of a country is inelastic, that country will enjoy a favorable terms of trade while if the exports are more elastic than imports, then the country will lose in the terms of trade.

5. The Govt : Elasticity of demand is useful in formulation Govt. Policy particularly taxation policy and the policy of subsides if the Govt. wants to impose excise duty, or sales tax, the Govt. should have an idea about the elasticity of the product. If the product is elastic in nature, then the burden of the tax is shifted to the consumer and the demand might fall remarkably: on the other hand, if the demand is inelastic in nature, then any extra burden of indirect tax will not affect the demand to that extent.

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