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The concept of elasticity of demand can be applied in economic policy decisions in the light of the
following situations.:-
1. Business pricing decisions – revenue can be increased by increasing prices where demand is
inelastic; where demand is elastic, sales revenue could be increased by ? lowering prices.?
At the same time, its important to a firm when seeking to estimate the effect of price changes of
competing firms on its own – where demand is elastic a rational firm will decide to keep its
prices stable. This concept is also relevant when estimating or deciding on the nature and scope
of promotion activities such as advertising – persuasive advertising tends to make the demand
for commodities relatively price inelastic.
2. Production decisions: To producers (suppliers) elasticity of demand is relevant when deciding on
what price and quantity of inputs to purchase. Such decisions will depend on the elasticity of
demand of the final products for which the inputs help produce; If, for instance, demand
for the final product is inelastic, a firm may find it still viable to purchase such inputs at
relatively higher prices since the additional cost could be covered by increasing final product
prices. In situations of elastic demand for the final products, firms should be more careful in
making input purchases, at least ensuring that input prices are comparatively low because
any attempt to recover such costs, by increasing prices, tends to reduce sales and thereby necessitating a price reduction in-order to survive the competitive market ( the decision
becomes self defeating)
3. Government policy orientation from the standpoint of:
a) Estimation of revenue from indirect taxes – Those commodities which are highly price
inelastic in demand should be taxed more (eg alcohol and cigarettes). The government
should however take into account the need not to tax (or tax less) necessities such as food
products/services whose demand is inelastic as well; tax on such basic and most essential
goods/services tends to have negative welfare implications.
b) Protectionism: It?s in the interest of most governments to protect their domestic
Industries against unfavourable external competition (largely because of the state of unequal
footing between domestic and foreign industries producing virtually the same or close
substitute products) by imposing tariffs on imports. This policy can be effective only where
the domestic demand for both local and foreign substitutes is highly price elastic; an increase
in import prices by the amount of a tariff should be sufficient to deter or discourage
domestic demand for them, at least in favour of domestic substitutes (assuming that the
quality and other buyer benefits of the products remain the same.)
c) Discouraging consumption of certain products or services
d) Price controls/minimum wage guidelines
e) Regulation of farmer?s incomes especially during bumper harvest.
f) Devaluation policy.
Wilfykil answered the question on February 4, 2019 at 13:13
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Date posted: February 4, 2019. Answers (1)
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use diagrams to illustrate and explain the...(Solved)
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