Elasticity of Demand Meaning and Definition
The term elasticity was developed by Alfred Marshall, and is used to measure the relationship between price and quantity demanded. The law states that the price of a commodity falls, the quantity demanded of that commodity will increase, i.e. it explains only the direction of change in demand and not the extent of change. This deficiency is removed by the concept of elasticity of demand.
Elasticity means responsiveness. Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to change in its price.
According to E.K. Estham, “Elasticity of demand is a measure of the responsiveness of quantity demanded to a change in price”.
According to Muyers “Elasticity of demand is a measure of the relative change in the amount purchased in response to any change in price or a given demand curve”.
According to A.K. Cairncross “The elasticity of demand for a commodity it is the rate at which quantity bought changes as the price changes.”
Types of Elasticity of Demand
These are three types of elasticity
1. Price elasticity
2. Income elasticity – It is of three types.
a) Zero income elasticity
b) Negative income elasticity
c) Positive income elasticity
3. Cross elasticity – It is of two types.
a) Advertisement elasticity and
b) Elasticity of price expectation.
Importance of Elasticity of Demand
1. Determination of price policy:
While fixing the price of this product, a businessman has to consider the elasticity of demand for the product. He should consider whether a lowering of price will stimulate demand for his product, and if so to what extent and whether his profits will also increase a result thereof.
2. Price discrimination:
Price discrimination refers to the act of selling the technically same products at different prices to different section of consumers or in different in sub-markets. The policy of price-discrimination is profitable to the monopolist when elasticity of demand for his product is different in different sub-markets. Those consumers whose demand is inelastic can be charged a higher price than those with more elastic demand.
3. Shifting of tax burden:
To what extent a producer can shift the burden of indirect tax to the buyers by increasing price of his product depends upon the degree of elasticity of demand. If the demand is inelastic the larger part of the indirect tax can be shifted upon buyers by increasing price. On the other hand if the demand is elastic than the burden of tax will be more on the producer.
4. Taxation and subsidy policy:
The government can impose higher taxes and collect more revenue if the demand for the commodity on which a tax is to be levied is inelastic. On the other hand, in ease of a commodity with elastic demand high tax rates may fail to bring in the required revenue for the government. Govt., should provide subsidy on those goods whose demand is elastic and in the production of the commodity the law of increasing returns operates.
5. Importance in international trade:
The concept of elasticity of demand is of crucial importance in many aspects of international trade. The success of the policy of devaluation to correct the adverse balance of payment depends upon the elasticity of demand for exports and imports of the country.
6. Importance in the determination of factors prices:
Factor with an inelastic demand can always command a higher price as compared to a factor with relatively elastic demand. This helps the trade unions in knowing that where they can easily get the wage rate increased. Bargaining capacity of trade unions depend upon elasticity of demand for workers services.
7. Determination of sale policy for supper markets:
Super Markets is a market where in a variety of goods are sold by a single organization. These items are generally of mass consumption. Therefore, the organization is supposed to sell commodities at lower prices than charged by shopkeepers in the other bazaars. Thus, the policy adopted is to charge a slightly lower price for items whose demand is relatively elastic and the costs are covered by increased sales.
8. Pricing of joint supply products:
The goods that are produced by a single production process are joint supply products. The cost of production of these goods is also joint. Therefore, while determining the prices of these products their elasticity of demand is considered.
9. Effect of use of machines on employment:
The use of machines may reduce the cost of production and price. If the demand of the product is elastic then the fall in price will increase demand significantly. As a result of increased demand the production will also increase and more workers will be employed.
10. Public utilities:
The nationalization of public utility services can also be justified with the help of elasticity of demand. Demands for public utilities are generally inelastic in nature. If the operation of such utilities is left in the hand of private individuals, they may exploit the consumers by charging high prices.
11. Output decisions:
The elasticity of demand helps the businessman to decide about production. A businessman chooses the optimum product- mix on the basis of elasticity of demand for various products. The products having more elastic demand are preferred by the businessmen. The sale of such products can be increased with a little reduction in their prices.
From the above discussion it is amply clear that price elasticity of demand is of great significance in making business decisions.