Scribd
Upload
105 views5 pages

Price Elasticity of Demand Applications

The document outlines 9 practical applications of price elasticity of demand: 1) Determining how changes in price affect demand. Demand is more sensitive to price changes if it is elastic. 2) Knowing how changes in price affect total revenue. Revenue increases if demand is inelastic and decreases if demand is elastic. 3) Monopolies set price based on elasticity - lower if demand is elastic, higher if inelastic. 4) Price discrimination allows different prices based on differences in elasticities between markets. 5) Unions' bargaining power depends on elasticity - they are stronger if demand for labor is inelastic. 6) Governments consider elasticities to maximize tax revenue - taxes are more

Uploaded by

ramkrishnagn
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
105 views5 pages

Price Elasticity of Demand Applications

The document outlines 9 practical applications of price elasticity of demand: 1) Determining how changes in price affect demand. Demand is more sensitive to price changes if it is elastic. 2) Knowing how changes in price affect total revenue. Revenue increases if demand is inelastic and decreases if demand is elastic. 3) Monopolies set price based on elasticity - lower if demand is elastic, higher if inelastic. 4) Price discrimination allows different prices based on differences in elasticities between markets. 5) Unions' bargaining power depends on elasticity - they are stronger if demand for labor is inelastic. 6) Governments consider elasticities to maximize tax revenue - taxes are more

Uploaded by

ramkrishnagn
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 5

Price Elasticity of Demand (Practical

Applications)
Article shared by:
The following points highlight the nine main practical
applications of the concept of price elasticity of demand. The uses
are: 1. Effects of changes in price upon demand 2. Effects of
changes in price on revenue 3. Monopoly pricing 4. Price
discrimination 5. Wage bargaining by trade unions 6. Importance
in taxation 7. Importance in determining the incidence of
taxation and few others.

Practical Application # 1. Effects of Changes in Price Upon


Demand:

The concept is very useful to study the reactions of the demand


for a commodity to the changes in its price. If the demand is
elastic, a small change in the price brings about a considerable
change in the quantity demanded, but in the case of inelastic
demand this consequential change in demand is relatively small.
So, the concept is relevant to the decisions relating to business
pricing and profits.

Thus, the fixing of price of a commodity is crucially based on the


elasticity of demand of the commodity. As Bates and Parkinson
put it: “When costs are rising, it is tempting to pass on the cost
increases by increasing price to the consumer, and if demand for
the product is relatively inelastic, this measure may well succeed;
and when, as for example in the case of rail transport, there are
many substitutes and the demand is relatively elastic, increasing
prices may well lead to a reduction of total revenue rather than an
increase.”

Practical Application # 2. Effects of Changes in Price on


Revenue:

The concept enables us to determine the condition of equilibrium


of a firm. And a profit-maximising firm reaches equilibrium when
revenue = marginal cost.
ADVERTISEMENTS:
And, the value assumed by MR depends on price
elasticity of demand:

MR = P (1 – 1/E p) where Ep is coefficient of price elasticity.

Thus, we could easily assert from this relationship that

(i) When E p = 1 (unit elasticity of demand),


ADVERTISEMENTS:

MR = AR x (1 -1) = 0. It means that a change in price will not


affect total revenue.

(ii) When Ep → α (perfectly elastic demand),

MR = AR x (1 – 0) = AR, as under perfect competition.

So, a firm may raise the price of its product(s) if demand is


inelastic, in which case sales and profits would not be affected. In
case of a commodity with elastic demand, a reduction in price
alone can raise the sales volume and, consequently, profit.

Practical Application # 3. Monopoly Pricing:

The concept is useful in monopoly price- decisions. The


monopolist, being the sole supplier of a particular commodity,
can raise price but cannot affect demand pattern of consumers.
So, in fixing the price the monopolist will have, of necessity, to
take note of the elasticity of demand for his product. He will fix
the price at a low level when the demand is elastic and at a high
level when it is inelastic.
ADVERTISEMENTS:

Moreover, a profit-maximising monopolist will always operate on


the elastic part of his demand curve or his average revenue curve.
Neither too high nor too low a price may enable him to realise his
objective: profit maximisation. What will be the profit-
maximising price will be dictated by elasticity of demand; and it
will enable the monopolist to know exactly at what price sales
proceeds or total revenue will be the highest.
Practical Application # 4. Price Discrimination:

In perfect competition, the same price is charged from all the


buyers. But, the downward slope of the demand curve of the
monopolist gives scope for price discrimination. Price
discrimination refers to the practice of charging different prices
for the same product from different buyers at the same time. It
can be profitably practised only when price elasticity of demand
differs from market to market or from one segment of the market
to another.

Practical Application # 5. Wage Bargaining by Trade Unions:

The bargaining power of the trade unions in raising the wages of


a group of labour in a particular industry also depends, among
other things, on the elasticity of demand for their services to the
employer. A trade union usually succeeds in raising wages when
the demand for the services of labour to the employer is inelastic:
because, in such a case the employer cannot easily dispense with
their services. On the other hand, it may not succeed when
demand for labour is elastic.

Practical Application # 6. Importance in Taxation:

Furthermore, the concept is a useful tool in taxation. A finance


minister is to consider the elasticity of demand of the different
commodities for the purpose of taxation. If he pushes commodity
tax (excise duty) rates up too much the consequent increase in
price may make the total tax yield even lower than before. On the
other hand, a small tax reduction may result in an increase in the
tax yield.

Firstly, the total expenditure by the consumers will determine the


size of the tax yield. And, the total expenditure is the measure of
elasticity of demand. If, however, the government simply wishes
to discourage the consumption of a commodity which happens to
have a highly inelastic demand—e.g., in case of cigarettes — the
imposition of a tax may have very little effect on demand and tax
collections may rise.

So, before imposing a tax or raising the existing rate of a tax, the
government will have to consider the elasticity of demand of the
commodity concerned. It can get more revenue from the taxes
imposed on commodities with inelastic demand (like sugar,
clothes, kerosene oil, etc.) than what is possible from the taxation
of those with elastic demand (like refrigerators, motor cars, steel
furniture’s, etc.). It so happens because in the former case taxes
may raise their prices but their demand and sales will not fall
very much; but, in the latter case taxes, by raising the prices,
reduce the demand and sales considerably.

Practical Application # 7. Importance in Determining the


Incidence of Taxation:

The concept of the elasticity of demand, along with that of supply,


is used to determine the shifting and incidence of a tax. When a
tax is imposed on a commodity of inelastic demand, the seller can
generally transfer the burden of the tax upon the consumers by
raising the price, and so the incidence of tax falls upon the
buyers.

But, in the case of a tax on a commodity with elastic demand,


such a shifting of tax is not an easy task. Similarly, in the case of
import and export duties on commodities the inelasticity of
demand can be used to determine the incidence of such duties.

Practical Application # 8. Price Determination of Joint-cost


Products:

Again, in the case of the joint-cost products (e.g., cotton fibre and
cotton seeds) where the cost of each cannot be separately
determined, the criterion of demand elasticity is applied in
determining their individual prices.

Practical Application # 9. Economic Policy:

The knowledge of elasticity is also valuable in the formation of


economic policies, too. This point may now be illustrated. A
country suffering from balance of payments problems may try to
tackle the imbalance by devaluing its currency.

But, whether devaluation will be successful or not crucially


depends upon other countries, i.e., the rest of the world’s demand
for the devaluing country’s products. If the demand for its
products is inelastic there will be no increase in volume sold after
devaluation, and consequently export earnings will fail due to
lower unit price of its product (sales remaining constant).

You might also like