The Minister of Finance can be more sure of his revenues if he taxes those commodities for which the demand is inelastic. The tax will no doubt raise the price but the demand being inelastic. people must continue to buy the same quantity of the commodity. Tit Us. the demand will not decrease. But, on humanitarian grounds. such taxes arc generally avoided. Since such commodities arc necessaries of life, their taxation is bound to affect public welfare. lollop Price. In the same manner. the businessman, especially if he is a monopolist, will have to consider the nature of demand while fixing his price. In case it is inelastic, it will pay him to charge a higher price and sell n smaller quantity. If, on the other hand the demand is elastic. he will lower the price. stimulate demand and thus maximize his monopoly net revenue. In a competitive industry. however. demand even for necessaries produced by a particular firm is elastic. No firm is in a position to dictate any price.Economic Policies. Modern governments regulate output and prices. In this, they are guided by the nature of consumer demand. They have also to control business cycles and inflationary pressures and check deflationary trends. For these purposes again. the nature of demand will have to be taken into consideration. The government can create public utilities where demand is inelastic and monopoly element is present.
Thus, it can be easily seen that the concept of elasticity of demand is of. immense utility in the business world, because the degree of responsiveness of demand to changes in price affects the total revenue (i.e., Price x Quantity sold) of the businessman, the seller. When the demand is elastic elasticity is greater than I), a fall in the price of the commodity will lead to more than proportionate increase in the quantity sold. This means that the total revenue will go up, because the increase in the quantity sold will more than compensate for the fall in price. On the other hand, if the demand is relatively inelastic (i.e.. elasticity less than unit· or I •the increase in the quantity sold will be than proportionate to a fall in price. As a consequence the total revenue will fill. It follows, therefore. that it pay a businessman to lower the price of his product when the elasticity of demand for his product is greater than unity (i.e., the demand is relatively elastic). However, the total revenue will not be affected, if the elasticity of demand is unity, because increase in the quantity sold will just compensate for the fall in price.
Price Discrimination. preconception of elasticity of demand is useful in explaining the conditions under which price discrimination by a monopolist becomes profitable. Price discrimination is found to be profitable if elasticity of demand in one market is different from elasticity of demand in another. The monopolist can charge a higher price in the market where elasticity of demand is less and a lower price where elasticity of demand is greater.
Classification of as Substitute and Complements. Goods arc classified as substitutes on the basis of cross elasticity. Two commodities may be considered as substitutes if cross elasticity is positive and complements when elasticity is negative. Boundary lit-tween Industries. Cross elasticity of demand is also useful in indicating boundaries between industries. Goods with high cross elasticizes constitute one industry. whereas goods with lower elasticity constitute different industries, lurker Forms. The concept of cross elasticity helps to understand different induct [onus. Infinite cross elasticity indicates perfect competition. whereas zero or near zero elasticity indicates pure monopoly and high elasticity indicates imperfect- competition. Incidence of Taxes. The concept of’ elasticity of demand is used in explaining the incidence of indirect taxes like sales tax and excise duty. Less is the elasticity of demand higher the incidence, and vice casa. In case of inelastic (or less elastic) demand the consumers have to buy the commodity and must bear the tax.
In the case of imperfectly competitive firms, whether a pure monopolist or a monopolistic ally competitive producer, the demand curve slopes downwards to the right. Such producers sell a significant proportion of the industry’s total output: Hence, by increasing or decreasing the output, they arc able to influence the market price. That is, they can sell more hey reducing the price and if they decide to reduce output and sell less, the price can be raised. Such a situation can be represented by the downward sloping curve. In other words. the demand schedule is less than perfectly elastic.