Role of Various Elasticities in Operations of Government and Business - Literature review Example

Student Name Tutor Title: Role of Various Elasticities in Operations of Government and Business Institution Date Role of Various Elasticities in Operations of Government and Business Introduction Various authors recognize the need to understanding the various elasticities of demand and their importance for both government and business operations is an important and timely topic (Swinton and Thomas, 2001; Richard and Zolt, 2003; Parkin, 2005 and Gamble et al, 2011). According to Eisenhauer and Principe (2009) Knowledge of various elasticities of demand has several implications. In particularly, it is an essential concept for business managers and government or policymakers to comprehend. It can provide a possible enlightenment on the inconsistency between the assumption of great knowledge in competitive business and the greatly flawed information of price which is empirically apparent among customers in most research. Moreover, better information of prices might be employed predominantly to deduce better price elasticity of demand where the price-elasticities of demand for particular products have been unanticipated although measures of customer price information are obtainable. On the other hand, it is often dismissed as excessively abstract and deficient of actual world application. According to these two scholars, most student and interested parties are usually not provided with “live” datasets with which to experiment in applying elasticity concepts. Preceding studies show that customers frequently display astonishingly lack of knowledge of goods prices (Eisenhauer and Principe, 2009). The present study is a critical review on the statement that knowledge of various elasticities of demand is useful for effective operation of business and government. The starting point is a conceptualization of key terms followed by a detailed discussion of implications of knowledge of elasticities of demand for government and business alike and finally a conclusion drawn from the discussion. Conceptualization of Key Concept The Elasticity of Demand Jain and Kanna (2006) describe elasticity of demand as a technical concept seen as a measure of the receptiveness of one variable to modification in other. According to the two, demand for a good depends on price, earnings of the customer and price of associated products described in details in the following section. Price Elasticity of Demand This is a calculation of percentage variation in amount required emanating from a 1 percent variation in price (Ringel et al, 2000). On the other hand, Perloff (2008) defines “Price elasticity of demand as calculations of the percentage variation in amount demanded brought about by a percent adjustment in price”. In his words, it determines the degree of movement down the demand curve and is approximately constantly negative and articulated in terms of total value, which is as a positive numbers because the negative can be unspecified. Income Elasticity of Demand This calculates the percentage variation in demand brought about by a percent variation in profits (Negbennebor, 2001). According to Ringel and his collogues, income elasticities of demand is usually measured as the fraction of the percentage variation in quantity required to the percentage variation in profits”. Hence, the demand for a good may be income elastic, incase customer demand is incredibly receptive to income variations, or income inelastic, incase income variations have extremely slight impact on demand (Ringel et al, 2000). The cross-price elasticity Unlike the foregoing elasticities, this determines the percentage variation in demand for a specific product brought about by a percent variation in the price of a different product. The demand curve shift showing a change in demand for original product if there is a change in the price of associated product. The direction and how far the curve shift horizontally along the X-axis is measured by cross price elasticity (Zweifel, and Manning, 2000). Importance of knowledge Various Elasticities of Demand The concept of elasticities of demand is of great significance for business and government efficient operation. This is discussed in the following subheading. Complement substitute unrelated Price elasticities of demand Price elasticities of demand to Government For the government efficient operation, the knowledge of price of elasticities of demand can be useful for formulation of policies in the following grounds; Planning of new taxes The government must comprehend price elasticity of demand to price society products and to establish rates of taxation on specific goods. The government has to have the knowledge of elasticities of demand in order to plan new taxes for its effective operations. According to Jain and Kanna (2006) taxes of goods having elastic demand usually elicit less revenue. Accordingly, taxes also raises their prices consequently bringing down their demand, hence less demand mean less revenue. On the other hand, goods having inelastic demand are taxed at a higher rate causing the prices of goods to rice on the account of these taxes. Again, more taxes will accrue to the exchequer. The financial impact of an excise tax is to change the market supply curve of the product that is taxed to the left. The customer and manufacturer are equally affected by the excise tax. The customer experiences increased prices while the manufacturer experiences decrease in sales and returns. The demand curve become more inelastic if there is lesser change emanating from the quantity demanded of the product while the levy is increased or originally taxed. Moreover, as elasticity reduces, a larger quantity of the duty load is experienced by the customer and a smaller amount is experienced by the manufacturer (Samuelson and Nordhaus, 2001). The same view is shared by Gamble and his collogues who argue that when demand is linear, and supply is perfectly elastic, tax revenue is maximized at a per-unit tax that causes demand elasticity to increase to twice its initial value, plus one (Gamble et al, 2011). Parkin (2005) observes, “The most heavily taxed items are those that have either a low elasticity of demand or a low elasticity of supply. For these items, the equilibrium quantity doesn’t decrease much when a tax is imposed. So the government collects large tax revenue….: With an elastic supply and demand, a tax brings a large decrease in the equilibrium quantity, and small tax revenue”. However, sometimes tax revenue may be greater when goods with elastic demand are taxed. If a good has elastic demand and is widely purchased with high prices, then the imposition of an excise tax may cause a larger percentage decrease in quantity. Arnold (2004) offers an example to demonstrate that levying low-elasticity products leads to more income. Distribution of taxation Governments utilize various types of taxes and show a discrepancy in the tax rates. It does this to allocate the tax load among people or classes of the residents caught up in taxable tasks, for example industry or to reallocate resources between people or classes in the residents. Furthermore, taxes are used to support foreign aid and military projects, to enhance the macroeconomic performance of the country, or to adjust patterns of expenditure or employment in the market, by making some types of transaction more or less attractive (McCluskey, et al., 2005). For determining the burden of indirect taxes for instance sales, tax, excise duty among other things in producers and consumers. If the demand is inelastic, the burden of indirect tax will be more on consumers. According to Jain and Kanna (2006) prices of goods can increase due to imposition of tax, but demand being inelastic will not contract. In this case situation, burden on the producers will comparatively be less whereas if the demand is elastic, the burden of indirect tax will be more on producers. Policy of nationalization Understanding of elasticities of demand is also important for the policy of nationalization. Jain and Kanna (2006) argue that a policy by virtue of which industries and enterprises are trough under ownership, control and management of the government is called policy of nationalization. Government nationalize thee enterprises, demand for whose product in inelastic for instance electricity, supply of water, telephone. In most cases, prices of these essential servicers can be charged very high if the government allows these to by b run by private enterprises. They exploit consumers by raising very high the prices of these services. To protect the consumers, the government normally nationalizes these public utility services. The government designed its latest National Hospital Insurance system to accomplish two vital goals: providing equal access to health care to every citizen and managing entire health expenditure to a realistic height (Cheng and T.L. Chiang, 1997). Price Control policy The government must take account for elasticity of demand for a commodity before imposing statutory price control on it. In addition, in order to stabilize prices say of agricultural goods, the government must also know the level of demand and elasticity of co-efficient. In the event that large stocks and falling prices, the government follows the policy of output control while daring periods of shortages and rising prices, it follows the policy of procuring stocks in surplus areas and disposing it in the deficit areas. Prices of almost all energy and definite extra non-labor inputs are regulated by the government in Pakistan. The Pakistan government as well promotes the provision of comprehensive credit services to the industrial manufacturers. Additional, it has as well frequently announced regulations in duties and tariffs on products utilized in industrial manufacturing. On the contrary, government as well enforces taxes on products. It can wish to tax new taxes on the industrial inputs. Every intercession has intense connotations for manufacturers, customers and the government in a similar way. Hence, it is imperative to distinguish how they may influence the industrial input demand. Additional, it is likewise imperative to know how successful they can be for the government in the achievement of its goals. The mainly relevant strategy to determine the industrial input demand reaction to government involvements is to get suitable approximations of price elasticities. Actually, capable elasticity approximations of the manufacturer input demand obtained with a sound method may act as a concrete foundation to forecast manufacturer reaction to market adjustments and thus the success and attractiveness of government involvements. Despite the fact that the price elasticities of goods throughout the years have been estimated for Pakistan, new interest on estimating receptiveness of manufacturer input demand with contemporary estimation measures has lately surged. Idrees (1997) and Khan (1998) have come up with elasticities for the home large-scale industrialized sector from a demand system. Fixing rate of exchange While fixing a proper rate for its currency for the government need to understand the concept of elasticity of demand particularly when considering a decision to devalue or revalue the countries currency; the government has to carefully take considerable of the concept of elasticities of demand when taking a decision to revalue or devalue the countries currency, the government has to carefully study the impacts of a such decision, elasticities of demand for its exports and imports comes handy in analysis of these impacts (Chiang and Wainwright, 2005; Goodwin et al., 2009). The government must comprehend price elasticity of demand while pricing the products that it offers to the society for example water and electricity services. Protection of rate of exchange While protecting or giving subsidy to an industry, the government keeps in mind the elasticities of demand for its products and generally gives protection of these industries whose products demand is elastic and does not give any protection to those industries whose demand is less elastic. Importance of price elasticities of demand to Business Companies could wish to capitalize on profits, and use of price elasticity of demand to establish the most excellent pricing policy. According to Jain and Khanna (2006) other things equal, customers will purchase more good when its price reduces and fewer when its price goes up. However, the more or less consumers buy differs from good to good and over various price choices for the similar good. According to the two scholars, it may also vary over time. Determining price policy Price elasticity of demand shows how susceptible the quantity demanded is to a variation in price. Companies are interested in this very much since it assists them in deciding the prices of their products. Companies must comprehend price elasticity of demand for the products they trade so as to settle on their most favorable pricing policy. For example, the company would discern that price reductions would increase the quantity of sales, therefore rising entirety income when demand is moderately elastic. Similarly, the company would raise prices, resulting in a rise in total income, because the decrease in sales could be less than proportionate when demand is moderately inelastic. Knowledge of the elasticity of demand in various price choices is vital in establishing the top pricing policy for a company and in choosing if to adjust prices. Therefore, companies frequently participate in statistical market study so as to establish customer preferences, and specifically, the price elasticity of the demand for their good. Moreover, it as well assists in assessing how much a company may have expanded or lost while prices are increased or decreased. Determining of price under monopoly A monopoly always takes into consideration price elasticity of demand of its price while determining its products or prices- if it is elastic the businessman or woman will fix low price per unit. Low price means more demand, large sales and hence large total revenue. If demand is inelastic, the business woman or man will fix high price per unit. High price with demand remaining more or less constant that is being inelastic means large total revenue. Price discrimination When a monopolistic sells his products at different prices is called process discrimination this is practical when price elasticity of demand for different users is different – charge more price for inelastic demand and less price for elastic demand e.g. electricity for domestic use is inelastic, so electricity board charges high rates of electricity of domestic use. Price determination joint supply Goods which are produced simultaneously in the same act of production are called a joint supply for instance cotton and cotton seeds; elasticity of demand for such goods is taken into consideration. While fixing their prices :if demand for cotton inelastic and cotton seeds elastic the price for cotton will be high and that of cotton seeds will be less. Dumping This basically means selling of goods in a overseas market at a price lower than that of domestic market. This is only useful if the demand of products is elastic then the seller does not get much profit when commodity is selling as an inelastic demand. Remuneration of factors of production According to the theory of factor price the returns of each factor depends upon elasticity of demand of services. If demand of production is inelastic the producer will be prepared to a higher price for it. On the other hand if the demand is elastic its returns will be lower therefore, the producer has to pay less or at the prevailing price for hiring its services. Importance of cross elasticities This helps certain business to mould their business for instance; edible oil producer may find the demand for oil increases when price of ghee rises. Sugar manufacturer may find the demand of sugar in relation to changes in prices of gar. Importance of income elasticity Decision regarding investments: The rise in nation income does not affect demands of various goods uniformly from the point of view of producers this effect is key as it helps in relocating resources among different industries. They would invest more in those industries where the income elasticity of demand is greater than unity. As demand for this products increase relative to income, there will be investment in more consumer durable goods like cars, TV, increases rapidly as the country progresses and its national income raises. For industries with low income elasticity of demand, the demand raises only slowly with income investment in such countries also rises slowly. Forecasting of demand; Knowledge of income elasticity is useful in forecasting the influence of possible changes in economy activity on demand. If the income changes there are greater likely-hood of changes in demand since change can be planned and sometime habits modified. Temporary changes demand will change very slowly. In the words of Armstrong and Green (2011) Demand forecasting asks “how much can be sold given the situation and the marketing program?” The circumstances involves the larger financial system, communications, the social background, the legal structure, the market, dealings of the company, measures by those providing rival and complementary goods, and measures by others for example unions and lobby movements. However, future demand is also affected by factors other than income. Classification of commodities: Income elasticity can help the business man classify his commodity for instance when income elasticity is positive the commodity can be said to be of normal type whereas when income elasticity is negative commodity can be said to be inferior for instance cereals millet Income coefficient is positive but less than unity, the commodity is an essential demand for maize –is income inelastic (Samuelson and Marks 2003). On the basis of this, business decides what to produce, how much to produce and to whom to produce. Argument against the statement, knowledge of various elasticities of demand as useful for government and business on the following grounds: Lack of full knowledge of demand: Sometimes firms may have knowledge about marginal cost but not have full knowledge of marginal revenue attributed to the fact that for the firms it is not possible to make anticipation of demand for want of the estimates of demand firms fail to maximizing profit (Farnham, 2005). Another argument relates to issue of profit maximization from a joint stock where the goal of joint stock companies may be different. This is because Joint Stock Company is usually run by manager and as long as shareholders get satisfactory return of the investment, they will not interfere with working of the managers. It is argued that interest of managers is often development of companies and increasing salaries or perks. Because of this, they tend to strive for other things rather than maximizing of profits. In terms of price of elasticities of demand and tax, Blackwell (1991) observed that blindly tackling the comparative excise tax crisis as an elasticity application is a possible severe fault. Graves, et al. (1996) argue that the elasticity-tax plan debate would not be confounding if slopes, instead of or at least in combination to elasticity were utilized. On the other hand, Swinton and Thomas (2001) contend that employing arc opposed to point elasticity would simplify the debate. Price elasticity of demand does not fully capture the effect of all three variables and thus does not fully explain tax revenue potential. Elsewhere, Bird and Zolt (2003) argue that there are countries which still experience important troubles in tax policy because of globalization and other issues. Even though the third world countries may experience fiscal disputes because of deep reliance on business taxes, those countries experiencing a developing economy have to as well deal with possibly difficult and significant troubles in the earnings tax area. In conclusion, it clear that despite the few arguments against the statement that knowledge of various elasticities of demand is necessary for efficient operations of business and government, intimate understanding of this concept is very important. It particularly vital particularly in economics because human needs and wants that must be satisfied. This analysis is significant for businessmen and women who must come up with the best pricing policy so as to attain their objective, maximization of income. On the other hand, governments, need to not only price goods and services but also determine indirect taxes imposed on these goods and services. References Arnold, R. A. (2004). 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