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Price elasticity of demand is mainly of interest to the government for the purposes of taxation. Governments in most places impose sales taxes or value-added taxes. These sorts of taxes raise the price of goods and services to which they apply.
Governments need to know the price elasticity of demand for these goods and services so they can know the likely impact of the tax. If the demand for hotel rooms (for example) is very inelastic, then the government can increase the sales tax on hotel rooms without creating a situation where hotels lose business and tax revenues fall. Governments will not want to raise sales taxes on items that are very elastic. Therefore, governments need to know about pirce elasticity of demand.
Price elasticity of demand seeks to explain how a certain product’s quantity demanded by the market responds to variations in its price. In certain situations consumers have no choice but to purchase a particular product regardless of price increments in what is known as perfect inelastic demand. However, when demand for the product is perfectly elastic the consumers would not purchase and would instead opt for its alternatives.
Price elasticity of demand is thus important to the government because it directly impacts the tax regime of the economy. The government has a responsibility to balance or moderate the tax burden between consumers and producers. This is done to ensure that consumers have access to certain essential products and the producers maintain their ability to provide products and services and ensure profitability. For example, when a government increases taxes on a product exhibiting perfect inelastic demand the burden of the tax falls on the consumers because they have no option but to purchase. However, when the taxes are imposed on products exhibiting perfect elastic demand then the tax burden falls on the producers since they cannot pass it on to the consumers.
The elasticity of demand can determinate the rate of foreign exchange which is based on the elasticity of imports and exports.
The taxation policy depends also on the elasticity of demand because if the finance minister imposes a tax on an economic good, first it needs to analyze if the demand for that good is elastic or inelastic. For example, if the demand is elastic, the finance minister cannot raise the price of the good, but if the demand is inelastic, the tax can be increased in order for a larger revenue to be gathered.
The elasticity of demand can make the businessmen to increase or decrease the price for economic goods. The price is increased when the demand is inelastic, while the price is decreased when the demand is elastic.
The elasticity of demand can decide the amount of advertisement spent on an economic good. If the demand is elastic, then the sales can be increased only by a very well financed advertisement plan.
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