The concept of price elasticity of demand has a significant contribution in the field of industry, trade, and commerce.
The price elasticity of demand not only enables an organization to analyze economic problems, but also helps in solving managerial problems, not related to pricing decisions.
The importance of price elasticity of demand is explained in the following points:
i. Pricing Decisions:
Refer to one of the major role of price elasticity of demand. The price elasticity of demand helps an organization to determine the price of its products in various circumstances.
Such situations are as follows:
a. Under Monopoly:
Refers to the fact that under monopolistic market conditions, the price of products is determined only on the basis of price elasticity of demand. In monopolistic market conditions, if the demand is elastic, the price is set very low for per unit of product.
This results in high demand for the product due to low price. On the other hand, if the demand is inelastic, the price is set very high. The high price of a product with demand remaining the constant helps in generating the large revenue for an organization.
b. Price Discrimination:
Refers to a situation when different prices are charged from different consumers. For example, a monopolist charges more prices from consumers whose demand for products is inelastic. This implies high prices are charged from consumers whose demand does not change with change in the price of products. On the other hand, a monopolist charges less prices from consumers whose demand is elastic.
For example, the demand for electricity for domestic users is inelastic; therefore, the price of domestic electricity is high, whereas the demand for industrial electricity is inelastic. This is because the use of electricity for industrial purposes can be replaced with other fuels. Thus, price of industrial electricity is low as compared to domestic electricity.
ii. Formulation of Government Policies:
Refers to an important significance of the concept of price elasticity of demand. The government takes into consideration the price elasticity of demand while planning taxes. For example, tax on products having elastic demand generate less revenue for the government as the taxes increase the price of products, which results in decrease in demand.
On the contrary, a high rate of tax is levied on products having inelastic demand. Apart from this, the government also considers the price elasticity of demand before implementing any price control policy.