Importance of Elasticity of Demand

1st year POE - Principles of Economics Notes

Importance of Elasticity of Demand
* Importance

* Price Determines the Demand

* Monopoly

* Market Price



Importance

The concept of elasticity is not just an abstract idea its practical importance is very great.
(1) Importance For Government

The concept of elasticity of demand helps the finance minister of the monopolist. When it imposes a tax. When a tax is imposed the price tends to rise. But if the demand is very elastic it will considerably fall when the price has risen and thus the government will not be able to earn expected revenue. Thus this concept of elasticity of demand helps the government to impose the tax on a commodity whose demand lass elastic and hence earn valuable revenue.
(2) Importance for Businessmen

The businessmen also take cue from the nature of demand while fixing his price. IF the demand is inelastic he knows that the people must buy such commodities. Thus he will be able to change a higher price and big profits.
(3) Importance for Monopolist

The concept of elasticity of demand is of special importance to the monopolist. He is in a position to control the price and fix high price when demand is inelastic and low price when it is elastic will bring him the maximum profit.
(4) Application in Case of Joint Products

In case of joint products seperate costs are not ascertainable. Hence the producer will mostly be guided by the nature of demand while fixing the price.
(5) Determinitation of Wages

The concept of elasticity of demand influences the determination of wages of a particular type of labour. If the demand of particular type of labour is inelastic trade union can easily get their wages raised. On the other hand of the demand for labour is relatively elastic trade union trade unions may not be successful in raising wages.
(6) Importance for International Trade

The concept of elasticity of demand is used in calculating the terms of trade. Whenever a country fees an adverse balance of payment the government considers the elasticity of demand for the countries export and imports before devaluing its currency.

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Price Determines the Demand

The demand for the commodity is related to price. IT is always at a price. Prof. Beaham defines as under:
“The demand for anything at a given price is the amount of it which will be brought per unit of time at that price.”
Demand varies with price. It varies inversely with price. If the price rises the demand contracts and if the price falls the demand extends. This responsiveness depends on many factors the effective demand for necessaries generally do not change with price. In other words the effective demand for necessaries is inelastic. The may rise or fall but the effective demand for necessaries remain practically the same. The effective demand for comforts is elastic. In other words variation in for comforts is in perpotion to a change in price.

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Monopoly

Monopoly is that market from in which the single producer controls the whole supply of a single commodity that has no close substitutes.
Two points must be noted in regard to the definition. First there must be an individual owner it seller if. There will be monopoly. That single producer may be individual owner or group of partners or a joint stock company or any other combination of producers of the state. Hence there must be a sole producer or seller in the market if it is to be called monopoly.
Secondly, the commodity produced by the producer must have no close substitutes. Competing if he is to be called a monopolist this ensures that there must no rival of the monopolist. By the absence of closer substitutes we mean that there are no other firms producing similar products or product varying only slightly from that of the monopolist.
The above two conditions ensure that the monopolist can set the price of his product and can pursue an independent price policy.
“POWER TO INFLUENCE PRICE IS THE VERY ESSENCE OF MONOPOLY.”

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Market Price

Market price is the actual price that prevails in the market at any particular time. It never remains constant. It changes from day to day and even from moment to moment. It can change at any time at any moment.
Determination of Market Price

Market price is determined by the relative forces of demand and supply. The demand depends upon the satisfaction, which a consumer drives from the consumption of the commodity. Supply on the other hand depends upon the cost of production of the commodity. The consumer tries to achieve more and more satisfaction least possible expenditure. He does not pay more than the marginal utility of the commodity to him the seller on the other hand tries to maximize his profit by changing as much as he can. He will never accept the price which is less than the marginal cost of production of the commodity and thus marginal utility and marginal cost pf production are the two limits the maximum and the minimum and price is determined between these two limits, so we can say that,
“The price is determined at point where the amounts demanded and offered for sale are equal.”

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