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.
📋 Case Study: Soft Drink Company – Price Change Decision
❗ Scenario:
A soft drink company finds that demand for its 600ml bottle is highly price elastic.
💡 Analysis:
Market survey shows that a 10% increase in price reduces sales by 25%.
✅ Outcome:
Company decides to keep price low and instead focuses on increasing volume and promotional offers.
Exam Tip
When question asks "How is elasticity useful in pricing?", mention elastic vs inelastic demand and use a small example like the above.
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.
Step 1"Identify elasticity of demand for different goods"
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Step 2"Choose inelastic goods for higher indirect taxes"
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Step 3"Use tax policy to raise revenue and influence consumption"
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 🎯
Test Your Knowledge
Question 1 of 5
1. If demand for a product is highly elastic, a rise in price will: