Elasticity Of Demand In Decision-Making

The concept of elasticity is very useful to producers and policymakers alike. It is a valuable tool for deciding the extent of increase or decrease in price for a desired change in the quantity demanded for products and services in the firm or the economy. The practical importance of this concept will be clear from the following applications:

1. Price Fixation:
   Knowledge of elasticity of demand helps a businessman decide whether to cut or increase the price of his product or to shift the burden of any additional cost of production onto the consumers by charging higher prices. Each seller under monopoly and imperfect competition has to take into account elasticity of demand while fixing the price for his product. If the demand for the product is inelastic, he can fix a higher price.
2. Production:
   The elasticity of demand helps the businessman decide about production. A businessman chooses the optimum product mix based on the elasticity of demand for various products. The products having more elastic demand are preferred by the businessman. The sale of such products can be increased with a little reduction in their prices. Hence, elasticity of demand helps the producers to take the correct decision regarding the level of output to be produced.
3. Prices of Factors of Production:
   A factor with an inelastic demand can always command a higher price compared to a factor with relatively elastic demand. This helps trade unions in knowing where they can easily get the wage rate increased. The bargaining capacity of trade unions depends upon the elasticity of demand for workers’ services. Elasticity of demand also helps in determining the rewards for factors of production. For example, if the demand for labor is inelastic, trade unions will be successful in raising wages. It is applicable to other factors of production as well.
4. International Trade:
   Elasticity of demand helps in finding out the terms of trade between two countries. Terms of trade refer to the rate at which domestic commodities are exchanged for foreign commodities. Terms of trade depend upon the elasticity of demand of the two countries for each other’s goods. A country will benefit from international trade when it fixes lower prices for export items whose demand is price elastic and high prices for those exports whose demand is inelastic. The demand for imports should be elastic for a fall in price and inelastic for a rise in price. The terms of trade between the two countries also depend upon the elasticity of demand for exports and imports. If the demand is inelastic, the terms of trade will favor the seller country. If the demand is elastic, the terms of trade will favor the buyer country.
5. Tax Policies:
   The government can impose higher taxes and collect more revenue if the demand for the commodity on which a tax is to be levied is inelastic. On the other hand, in the case of a commodity with elastic demand, high tax rates may fail to bring in the required revenue for the government. Elasticity of demand helps the government in formulating tax policies. For example, when imposing a tax on a commodity, the Finance Minister has to take into account the elasticity of demand.
6. Nationalization of Public Utilities:
   The nationalization of public utility services can also be justified with the help of elasticity of demand. Demand for public utilities such as electricity, water supply, post and telegraph, and public transportation is generally inelastic in nature. If the operation of such utilities is left in the hands of private individuals, they may exploit the consumers by charging high prices. Therefore, in the interest of the general public, the government owns and runs such services.