Importance of Elasticity of Demand in Business Decisions

Elasticity is not just theory. It is a practical tool used by managers, marketers and even the government.

1. Pricing Decisions

• If demand is elastic → small increase in price causes big fall in quantity demanded.
  • Firms usually avoid high price.
• If demand is inelastic → even large change in price causes small change in quantity demanded.
  • Firms may increase price to raise total revenue.

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2. Output and Production Planning

• If demand for a product is elastic, firms may plan to increase output when they reduce price.
• If demand is inelastic, they may maintain or slightly reduce output even if price rises.

Elasticity helps avoid over-production or stock accumulation.

3. Wage and Employment Decisions

• Elasticity of demand for labour helps firms in deciding wage rates and employment levels.
• If demand for product is inelastic, firm may be able to pay higher wages without losing much sales.

4. Taxation Policy (Government Use)

• Government prefers to impose indirect taxes (GST, excise) on goods with inelastic demand (petrol, cigarettes):
  • Quantity demanded does not fall much → tax revenue high.
• If tax is imposed on goods with elastic demand, quantity demanded falls sharply → less revenue.

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5. International Trade & Exchange Rate Policy

• Elasticity of demand for exports and imports helps in devaluation decisions.
• If foreign demand for exports is elastic, depreciation of currency can increase export revenue.

6. Advertising and Sales Promotion

• For products with elastic demand, effective advertising can increase demand significantly.
• Firms study how responsive demand is to price vs advertising (concept of advertising elasticity).

7. Price Discrimination (Advanced Idea)

• Monopolists may charge higher price in markets with inelastic demand (less sensitive), and lower price in markets with elastic demand.

Example: Different cinema ticket prices for weekdays vs weekends.

8. Quick Revision Points

• Elasticity guides pricing, output, wages, taxation, trade and promotion decisions.
• High elasticity → be careful with price increase; focus on volume and promotion.
• Low elasticity → scope to increase price and tax without large fall in demand.

9. Quiz Time 🎯

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