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Tuesday, 3 May 2011

Practical importance of elasticity of demand

Elasticity of Demand :- " Elasticity of demand is the rate at which the quantity demanded changes with a change in price."

In other words we can say that elasticity of demand is the relationship between the proportionate change in price and the proportionate change in quantity demanded.

FORMULA : ED = Proportionate change in quantity demanded/Proportionate change in price.

PRACTICAL IMPORTANCE OF ELASTICITY OF DEMAND

This concept has a great practical importance in the sphere of government finance and in the commerce and trade due to the following reasons :

1. IMPORTANCE FOR FINANCE MINISTER :- Before imposing the taxes finance minister has to keep in view the elasticity of demand of various goods. If the demand is inelastic, he can increases the tax and thus can collect large revenue.

2. IMPORTANCE FOR THE MONOPOLIST :- If the monopolist finds that the demand for his product is inelastic, he will fix the price at a higher level, otherwise he will lower the price.

3. FIXATION OF WAGES :- If a demand of labour is inelastic, it is easy to rise their wages otherwise not.

4. INTERNATIONAL TRADE :- If the demand of commodity is inelastic then heavy duties can be imposed on its import heavy duties can be imposed on its import and export.

5. IMPORTANCE FOR THE PRODUCER :- Producer will study elasticity of demand before fixing the price of his commodities. Secondly, If the demand for a commodity is inelastic the producer will spend a large amount on advertisement for increasing the sale.

6. RATE OF FOREIGN EXCHANGE :- The rate of foreign exchange is also considered on the elasticity of exports and imports of the country.

7. TERMS OF TRADE :- The terms of trade between two countries are based on the elasticity of demand of the traded goods.

8. IMPORTANCE FOR THE BUSINESSMAN :- When the demand of good is elastic , businessman increase his sale by lowing the price. If the demand is elastic then he fixes high prices.

9. JOINT PRODUCT COST PROBLEM :- Sometimes it is very difficult to know the separate cost of each factor of joint products. Here elasticity of demand becomes very helpful in determining the cost of each factor of production.

10. IMPORTANCE FOR COMMUNICATION INDUSTRY :- The concept of elasticity is practically used in fixing the rates and fares of transfer of goods.

11. LAW OF INCREASING RETURN AND DEMAND :- When small industry is working under the law of increasing return, its demand should be elastic. So it will lower the price and increase the sale.

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