What is the Practical application of law of demand and supply in economics?

Answer 1

The law of demand denotes that a drop in the rate of a commodity hikes the volume demanded. The price elasticity of demand measures the volume demanded responds to a variation in price. Demand for a commodity is said to be elastic if the volume demanded reacts considerably to variations in price.

Demand is said to be inelastic if the volume demanded reacts only slightly to variations in the price. The price elasticity of demand for any commodity measures how enthusiastic consumers are to shift from the commodity as its price hikes. Therefore, the elasticity reproduces the many economic, social and psychological forces that shape consumer tastes. Depending on familiarity, nevertheless we can denote common rules about what ascertains the price elasticity of demand.

Answer 2

Practical usefulness of elasticity of demand

01) To Formulate Government Policies (In designing public finance policies)

Price elasticity of demand is very useful as an analytical tool in implementing of effective public finance policies. The way in which price elasticity of demand is used in designing public finance policies is explained below through few examples.

Example 01

Basically there are two objectives of imposing taxes on goods and services; increase in government revenue and discourage in consumption. There should be inelastic demand for the good if the government's objective is increase in tax revenue by imposing a tax and there should be elastics demand for the good if the government's objective is discourage in consumption in imposing tax.

Example 02

The main objective of granting a production subsidy is to provide a kind of benefit for producers by decrease in variable cost in order to stimulate production. Comparatively there should be elastic demand for the good to provide higher margin of benefit for produces in granting a subsidy. If the demand is comparatively inelastic, higher margin of benefit of a subsidy is acquired by consumers.

02) To Make Business Decisions.

Example 01

Increase in price is one of methods in increase in sales revenue by business firms. There should be inelastic demand if a business firm is expecting to increase in sales revenue by increase in price and there should be elastic demand if a business firm is expecting to increase in sales revenue by decreasing the price.

Example 02

Price elasticity of demand is useful in designing effective marketing strategies. For instance cost of regular advertising is added to the price. Impact of change in price of quantity demand depends on price elasticity of demand. Therefore concentration on price elasticity of demand is very important in designing advertising programs.

03) To Forecasting Demand.

Future demand can be forecasted accurately based on expected price changes if the price elasticity of demand is a known value. Estimation of demand is very important for reduction of inventory cost, designing of advertising programs, etc. demand can be forecasted in following manner.

04) To Measure Degree of Consumer Power in the Market

Higher price elasticity of demand indicates that consumers are having number of alternative products (options) in the market. So they can quickly change their quantity demand as responsiveness for change in prices. Therefore higher price elasticity (elastic demand) indicates higher consumer power and lower price elasticity indicates lower consumer power in the market.

Answer 3

The Law of Demand states that as prices rise demand decreases due to the cost. A practical example of this law would be the cost of gas. People may continue to commute to work alone if gas remains at $3.50 a gallon, but they may start to carpool when it reaches $4.50 a gallon, and may choose to use public transportation if it reaches $5.50 per gallon.

Answer 4

Elasticity allows us to analyze supply and demand with greater precision than would be the case in the absence of the elasticity concept.