Business Uses of Elasticity of Demand

Elasticity is not merely a classroom measure; it is a working tool that managers, sellers and governments use every day.

• Pricing and revenue decisions. A firm that knows its product's elasticity knows what a price change will do to revenue. For an elastic good, cutting price raises total revenue (the total-outlay test); for an inelastic good, raising price raises revenue. A firm selling a necessity with few substitutes can safely raise price; one selling a luxury with many rivals dare not.
• Price discrimination. A monopolist charges a higher price in the market with inelastic demand and a lower price where demand is elastic — for example higher fares for business travellers (inelastic) and cheaper fares for tourists (elastic).
• Government taxation. A government raising indirect tax revenue puts heavy taxes on goods with inelastic demand (petrol, cigarettes, liquor) because buyers cannot easily cut consumption, so revenue stays high; taxing an elastic good would drive sales — and revenue — down.
• Wage and factor pricing. The elasticity of demand for a product influences the bargaining power of the workers who make it; a strong union can win higher wages more easily when the product's demand is inelastic, since the higher cost can be passed on.
• International trade and the terms of trade. A country exporting goods with inelastic world demand can improve its export earnings, and elasticity guides devaluation and tariff decisions. …