What's the importance of price elasticity of demand to the government?
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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.
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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