What role does elasticity have on decisions made in the mark

What role does elasticity have on decisions made in the market? How does the availability of substitutes affect the price elasticity of demand? Explain using examples from your experiences.

Solution

The business firms take into account the price elasticity of demand when they take decisions regarding pricing of the goods. This is because change in the price of a product will bring about a change in the quantity demanded depending upon the coeffi­cient of price elasticity.

This change in quantity demanded as a result of, say a rise in price by a firm, will affect the total consumer’s expenditure and will therefore, affect the revenue of the firm. If the demand for a product of the firm happens to be elastic, then any attempt on the part of the firm to raise the price of its product will bring about a fall in its total revenue.

Thus, instead of gaining from the increase in price, it will lose if the demand for its product happens to be elastic. On the other hand, if the demand for the product of a firm happens to be inelastic, then the increase in price by it will raise its total revenue. Therefore, for fixing a profit-maximising price, the firm cannot ignore the price elasticity of demand for its product.

USES OF PRICE ELASTICITY OF DEMAND:

Uses in Economic Policy Regarding Price Regulation and Crop Restriction of Farm Products:

Governments of many countries, especially the United States of America provide subsidies per unit of the products produced to the farmers to give them incentives to produce more as due to inelastic nature of demand for farm products more production causes such a steep fall in the prices of farm products that leads to the decrease in incomes of farmers.

However, during the last over three decades, government in the United States helps farmers by adopting an unusual policy of requir­ing them to restrict production. To induce them to restrict output government provides subsidy to them for not planting crops on all their land (that is, for keeping some land uncultivated).

The purpose of restricting production in this way is to reduce their supply in the market so that price of the agricultural product in the market rises. In view of the fact that demand for agricultural product is inelastic a fall in production will cause their revenue or income to rise and will thus make them better off.

Explanation of the Paradox of Poverty amidst Plenty:

The concept of price elasticity of demand also helps us to explain the so-called ‘paradox of plenty’ in agriculture, namely, that a bumper crop reaped by the farmers brings a smaller total income to them. The fall in the income or revenue of the farmers as a result of the bumper crop is due to the fact that with greater supply the prices of the crops decline drastically and in the context of inelastic demand for them, the total expenditure on the crop output declines, bringing about fall in the incomes of the farmers.

Thus, bumper crop instead of raising their incomes reduces them. Therefore, in order to ensure that the farmers do not lose incentive to raise their production, they need to be assured certain minimum price by the Government. At that minimum price the Government should be prepared to buy the crop from the farmers.

Similarly, if due to research there is improvement in agricultural technology which leads to the substantial increase in agricultural output instead of raising farmers’ income may actually brings about reduction in it. This strange phenomenon is due to the inelastic nature of demand for agricul­tural products.

How does the availability of substitutes affect the price elasticity of demand? Explain using examples from your experiences.

More will be availability of substitutes, more will be elasticity of demand because consumers will have option of shifting to other product. For example, if I am the only Economics teacher in my area, I can any amount of fees from the tudents. bt if there are many teachers, I need to keep in mind the price being charged by my competitors. More will be my competitors, less will be my control over price and more will be price elsticty fo demand and vice versa.