Question

Q2:What is the effect or application of elasticity of demand in real life business?

Answer 1

Elasticity of demand is the degree of responsiveness of the quantity demanded of a commodity to a change in its price.

The concept of elasticity is crucial in managerial decision making as it has a direct bearing on profits. Raising the price of a product whose price elasticity of demand is less elastic, i.e., consumers are less responsive or indifferent to price changes, or products with less elastic substitutes, proves to be profitable for businesses.

Income elasticity :

- Income elasticity is useful in demand forecasting when the rate of change in income and income elasticities is given; the problem of over and under production can be effectively managed.

Substitutes and Complements :

- Cross elasticity of demand is also useful in making key pricing decisions. If cross elasticity in response to price of substitutes is greater than one, decreasing the price of the product would be beneficial ( goods that are substitutes like tea and coffee have a positive cross elasticity ).

- On the other hand, complements have a negative cross elasticity of demand. So, if cross elasticity in response to price of complements is greater than one, increasing the price of the product would be more beneficial.

Government policies:

• The government may impose taxes on products with less elasticity if it wants to increase revenue from taxes.
• Trade policies relating to tariffs also depend on the elasticity of demand for exports and imports.
• Correcting adverse Balance of Payments involves studying elasticity of demand for exports and imports. Devaluating currency requires knowing the elasticity of demand for a country's imports and exports.