Price Elasticity is used to explain the degree of responsiveness of the demand for a product to a change in its price.
Ep=Percentage change in quality demanded/Percentage change in price
Practical applications of Price Elasticity:
1) Helps in fixing the prices of different goods: It helps a producer to fix the price of his product. A higher price is charged if the demand for the product is inelastic and a lower price is charged if the demand for the product is elastic. Thus, the price-increase policy is to be followed if the demand is inelastic in the market and the price-decrease policy is to be followed if the demand is elastic.
2) Poverty in the midst of plenty: Inelastic demand for agricultural products helps to explain why bumper crops or rice or wheat depress the prices and total revenues for farmers.
3) Helps in fixing the rate of taxes: Governments look at elasticity of demand when levying excise taxes. Excise taxes on products with inelastic demand will raise the most revenue and have the least impact on quantity demanded for those products.
4) Demand for cocaine is highly inelastic and presents problems for law enforcement. Stricter enforcement reduces supply, raises prices and revenues for sellers, and provides more incentives for sellers to remain in business. Crime may also increase as buyers have to find more money to buy their drugs.
5) The concept of elasticity of demand is made practical use of by the Finance Minister and the monopolist. When the Government imposes a tax on a commodity, its price will tend to rise. But if the demand is very elastic, it will considerably fall when the price has risen. The result will be that Government will not get larger revenue from this tax because the people will have considerably curtailed their demand for it. If the Finance Minister, therefore, wants to be certain of the revenue from a particular tax he must levy it on such commodities for which the