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

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Kasey Baumann eNotes educator | Certified Educator

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Price elasticity of demand is the change in demand of a product based on the increase or decrease of the price of that product. It is of significant importance to the government because it is used to determine the tax incidence of each product.

The tax incidence is how the tax imposed on each product is divided between suppliers and consumers. When supply is more elastic (when consumers can substitute one product for another in response to an increase in price), suppliers pay more taxes than consumers. This is also known as inelastic supply. For example, when the price of rice increases, consumers will substitute the rice for a product such as pasta in response to the price change.

When demand is more elastic (when the demand for a product does not change regardless of the price), consumers pay more taxes than suppliers. This is also known as inelastic demand. For example, if the price of gas increases, consumers will still have to purchase gas in order to have transportation for their...

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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.