O Level Economics Paper-2 (Qamar Baloch)

Discuss the usefulness to businesses of knowledge of price elasticity of demand. [07] Price elasticity of demand refers to the responsiveness of change in quantity demanded due to change in price. It is calculated through the following formula: Price elasticity of demand = The knowledge of price elasticity of demand is of much importance for businesses because it helps to set pricing policies to earn more revenue and profits. If the businessman knows the nature of price elasticity of demand then he will charge the price accordingly. For example if the demand for the product is elastic then he can increase his revenue by decreasing the price, because a small decrease in price will lead to a larger increase in quantity demanded. Consequently, his total revenue will tend to rise. In this situation he will never increase his price because it will result in a dramatic fall in quantity demanded and finally total revenue will fall. On the other hand, in case of inelastic demand, a firm can increase his total revenue by increasing the price. A large rise in price will bring a smaller decrease in quantity demanded (i.e. less than proportionate). When demand is inelastic, businessman will never decrease his price because a fall in price will lead to decrease in total revenue. In case of unitary elastic demand fluctuation in price will not affect the total revenue. Any rise or fall in price will leave the total revenue unchanged. If the demand for a product is perfectly inelastic then a firm can earn more revenue by increasing the price, because rise in price will lead the quantity demanded unchanged. It means the knowledge of price elasticity of demand is of much importance for the businesses.