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

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Michael Koren eNotes educator | Certified Educator

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Most products are impacted by price elasticity. This means that as the price rises, the demand for the product will drop. Also, when the price drops, the demand for the product will rise. Since most items are impacted by price elasticity, the government needs to be aware of the effect of price on the demand for products.

This is important because government actions may impact the price of a product. The government levies taxes on products. These taxes include taxes on imports as well as sales taxes. If either of these taxes is too high, it may impact the consumer demand for the product. If...

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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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