Elasticity of demand refers to the measurement of sensitiveness of demand of a product to the change in economic variables like price, income etc. It shows how the demand of the product changes according to the change in other factors. Elasticity of demand is very useful for the company as well to the government to make various decisions and to formulate financial policies.
Uses/Significance Or Importance Of Elasticity Of Demand
Significance or importance of elasticity of demand can be highlighted as follows:
1. Helps To Determine Optimum Output
Elasticity of demand is important for the firms to determine optimum output level. Producers analyze the demand of the commodity (either it is elastic or inelastic) and make decision about the quantity to be produced.
2. Helpful To Determine The Price
Demand elasticity shows the fluctuation in demand of the product with the change in its price. Companies can set high price for products having inelastic demand and low in case of elastic demand. Therefore, it helps the firms to determine fair price of the products or services.
3. Useful In Factor Pricing
This concept is important in determining the price of factors of productions. Price of these factors are determined on the basis of their elasticity of demand. Higher price is set for factors having inelastic demand and vice versa.
4. To Make Automation Decision
Demand elasticity assists the management to make decision regarding automation in production process. Company can decide whether to replace labor with automated machines or not by measuring the elasticity.
5. Provides Basis For Price Discrimination
Price discrimination is a pricing strategy where companies sell same product or services at different prices to different customers and in different market segments. Firms set high price where the demand is inelastic and charge low price where the demand of the product is elastic.
6. Price Determination Of Joint Products
It is difficult for the company to determine the price of joint products. In this situation, firms analyze the elasticity of demand of both products and set high price for the product having inelastic demand and low for elastic one.
Also Read
Factors affecting elasticity of demand
Concept and methods of demand creation
Meaning of primary demand and secondary demand
7. Helpful For Long-term Planning
Elasticity of demand helps in demand forecasting. So, management can make long-term production planning.
8. Useful For Tax Purpose
Authority can make tax policy with the help of demand elasticity. If the demand is inelastic, then the tax will be higher and vice versa.
9. Useful For Government
It helps the government to make trade policies. It helps to subsidize public utilities that discourages customer exploitation.
