Importance of elasticity in economics can be understood with the help of following headings.
DEMAND Theoretical importance
The concept of elasticity of demand is very useful as it has got both theoretical and practical advantages. As regards its importance in the academic interest, the concept, is very helpful in the theory of value. In the words of Keynes. “the concept” of elasticity is so important that in the provision of terminology and apparatus to aid thought, I do not think, Marshall did any greater service than by the explicit introduction of the idea of the elasticity.
(1) Practical importance.
Importance in taxation policy. As regards its practical[ advantages, the concept has immense importance in the sphere of government finance. When a finance minister levies a tax on a certain commodity, he has to see whether the demand for that commodity is elastic or inelastic. If the demand is inelastic, he can increase the tax and thus can collect larger revenue. But if the demand of a commodity is elastic, he is not in a position to increase the rate of a tax. If he does so, the demand for that commodity will be curtailed and the total revenue reduced.
- Price discrimination by monopolist. If the monopolist finds that the demand for his commodities is inelastic, he will at once fix the price at a higher level in order to maximize his net profit. In case of elastic demand, he will lower the price in order to. increase his sale and derive the maximum net profit. Thus we find that the monopolists also get practical advantages from the concept of elasticity.
- Price discrimination in cases of joint supply. The concept of elasticity is of great practical advantage where the separate costs of joint products cannot be measured. Here again the prices are fixed on the principle. “What the traffic will bear” as is being done in the railway rates and fares.
- Importance to businessmen., The concept of elasticity is of great importance to businessmen. When the demand of a good is elastic, they increases sale by lowering its price. In case the demand’ is inelastic, they are then in a position to charge higher price for a commodity.
- Help to trade unions. The trade unions can raise the wages of the labour in an industry where the demand of the product is relatively inelastic. On the other hand, if the demand for product is relatively elastic, the trade unions cannot press for higher wages.
- Use in international trade. The term of trade between two countries are based on the elasticity of demand of the traded goods.
- Determination of rate of foreign exchange. The rate of foreign exchange is also considered on the elasticity of imports and exports of a country.
- Guideline to the producers. The concept of elasticity provides a guideline to the producers for the amount to be spent on advertisement. If the demand for a commodity is elastic, the producers shall have to spend large, sums of money on advertisements for increasing the sales.Use in factor pricing. The factors of production which have inelastic demand can obtain a higher price in the market than those which have elastic demand, This concept explains the reason of yariation in
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