Price Elasticity of Demand and Practical Application
Price elasticity of demand and practical application. Price elasticity of demand Price elasticity of demand is a measure to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price ( i.e. holding constant all the other determinants of demand, such as income).
Practical application of price elasticity : Practical application of price elasticity of demand are as follows:
1. Production planning – It helps a producer to decide about the volume of production. If the demand for his products is inelastic, specific quantities can be produce while he has to produce different quantities, if the demand is elastic.
2. Helps in fixing the prices of different goods – It helps a producer to fix the price of his product. If the demand for his product is inelastic, he can fix a higher price and if the demand is elastic, he has to charge a lower price. Thus, price-increase policy is to be followed if the demand is inelastic in the market and price-decrease policy is to be followed if the demand is elastic.
Similarly, it helps a monopolist to practice price discrimination on the basis of elasticity of demand.
3. Helps in determining the terms of trade – It is the basis for deciding the ‘terms of trade’ between two nations. The terms of trade implies the rate at which the domestic goods are exchanged for foreign goods, e.g. if the demand for Japan’s products in India is inelastic, we have to pay more in terms of our commodities too get one unit of a commodity from Japan and vice-versa.
4. Helps in determining the foreign exchange rates – Exchange rate refers to the rate at which currency of one country is converted in to the currency of another country. It helps in the determination of the rate of exchange between the currencies of two different nations. For e.g. if the demand for US dollar to an
Practical application of price elasticity : Practical application of price elasticity of demand are as follows:
1. Production planning – It helps a producer to decide about the volume of production. If the demand for his products is inelastic, specific quantities can be produce while he has to produce different quantities, if the demand is elastic.
2. Helps in fixing the prices of different goods – It helps a producer to fix the price of his product. If the demand for his product is inelastic, he can fix a higher price and if the demand is elastic, he has to charge a lower price. Thus, price-increase policy is to be followed if the demand is inelastic in the market and price-decrease policy is to be followed if the demand is elastic.
Similarly, it helps a monopolist to practice price discrimination on the basis of elasticity of demand.
3. Helps in determining the terms of trade – It is the basis for deciding the ‘terms of trade’ between two nations. The terms of trade implies the rate at which the domestic goods are exchanged for foreign goods, e.g. if the demand for Japan’s products in India is inelastic, we have to pay more in terms of our commodities too get one unit of a commodity from Japan and vice-versa.
4. Helps in determining the foreign exchange rates – Exchange rate refers to the rate at which currency of one country is converted in to the currency of another country. It helps in the determination of the rate of exchange between the currencies of two different nations. For e.g. if the demand for US dollar to an