How is elasticity useful to business firms and government?

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gsenviro | College Teacher | (Level 1) Educator Emeritus

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In economics, elasticity is a measure of how the demand or supply varies as the price of the product changes. Mathematically, elasticity is given as the ratio of % change in demand or supply to % change in the price of the commodity. If it is greater than 1, it is termed elastic and means that change in price will change the demand or supply significantly. Similarly an elasticity of less than 1 is termed inelastic and means that supply or demand does not vary much with changes in price of commodity.

A knowledge if elasticity is very important for both the government and the businesses. Government needs capital to work and it is generated from taxes. By knowing the elasticity of various products, government can decide the level of taxes that can be charged without harming the interests of the people. For example, heavy taxes can be levied on tobacco products such as cigarettes rather than milk or medicine. Such differential taxation can help government generate taxes without undue burden in people. A country's foreign exchange reserve is dependent on its imports and exports. Prices and taxes can be levied in such a way so as to keep such transactions favorable. To a business, the bottom line is of primary importance. It can decide on a commodity's price using the elasticity data and determine the price that will generate a certain demand and help the company meet their revenue targets. 

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