What is the practical importance of the knowledge of price elasticity of demand?

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gsenviro eNotes educator| Certified Educator

Elasticity of demand is a measure of change in quantity demanded to change in the commodity's price. An elastic demand is a scenario when small change in price causes significant change in demand. On the other hand, an inelastic demand is a case where large change in price level is required to change the demand by a small fraction. Price elasticity of demand is an important concept for both businesses and the government. Government can use this knowledge while determining the taxation policy. A commodity with an inelastic demand can be taxed at higher rate, as compared to something with an elastic demand. Businesses can decide the price level of their respective commodity in order to achieve their sales, revenue and profit targets. The knowledge can also be used to determine the foreign exchange a government is hoping to gain or spend by exchange of a certain commodity. If the commodity's demand is inelastic in the importing country, an exporting country can charge a higher price and gain more foreign exchange. It can also be used to determine the minimum support price the government is willing to pay the farmers for their produce.