2.2.11. Importance of demand elasticity

2.2.11.Importance of demand elasticity

The concept of demand elasticity has enormous significance in economics as it finds application in production, price fixation, price stabilization, distribution, international trade, foreign exchange rate determination and public finance. An understanding of elasticity of demand is required to frame economic policies also.

Price discrimination

Firms that have some control over their market price can sometimes use that control to enhance their profits by charging different prices to different customers. In particular, a firm engaging in price discrimination increases its profits by charging higher prices to those customers who have the most inelastic demand for the product and lower prices to those customers who have a more elastic demand. In essence, this strategy involves charging the highest prices to those customers who are willing to buy the commodity at a high price and charging lower prices to those customers who are more sensitive to price differentials.

A classic example of price discrimination occurs with airline fares. There are two general categories of customers: those traveling on vacations and those traveling for business purposes. It is likely that the demand for air travel by business travelers is less sensitive to price changes than is true for those on vacation. Airlines are able to charge different prices to these two groups by offering a high base fare and a "super saver" fare that requires a weekend stay, the purchase of the tickets several weeks in advance, and similar restrictions. Since those traveling for vacation purposes are more likely to satisfy these requirements than business travelers, airlines accomplish the goal of charging higher prices to the business travelers with less elastic demand and lower prices to those customers with more elastic demand who are flying for vacation purposes.

The use of cents-off coupons in the Sunday newspapers is another example of price discrimination that offers a lower price to those customers who have more elastic demands (since low-wage workers are more likely to be sensitive to price changes and are more likely to use coupons).

Child and senior citizen discounts at restaurants and movie theaters are also examples of price discrimination that result in lower prices being charged to those customers with the most elastic demand for the products.

Last modified: Monday, 26 December 2011, 9:40 AM