Why the concept of price elasticity important to (a) firms and (b) government

In Economics price elasticity is the concept that measures the sensitivity or responsiveness of the customers of a product or a service to the price changes. The mathematical definition of price elasticity is the below.
Price elasticity of demand measures the change in the demand of a product whenever a change in price applies. For example, if the price of a specific product increases by 10% and the demand decreases by 15% due to this price change, then the price elasticity for this product is -1.5. Demand, as related to the sensitivity to the price change, can be divided to three types. A demand can be elastic, unelastic or unitary elastic. An elastic demand of a product is the one where the price elasticity in absolute value is greater than 1. A product with elastic demand is strongly sensitive to any price change as the percentage of the change in demand is greater the percentage of change in price. An unelastic demand of a product is the one where the price elasticity in absolute value is smaller than 1. This means that a product with elastic demand is not very sensitive to price changes since the percentage of the change in demand is lower the percentage of change in price. A unitary elastic demand for a product is the one where the price elasticity equals with 1.
There are several factors that affect price elasticity. The most important factors are whether the product concerned is produced by a monopoly industry or by a competitive industry structure where there exist many substitutes. Another factor important factor is whether the product type is normal or inferior (Kench, 2008). Price elasticity is a great tool in the managers decision toolbox. Thomas and Maurice claim that the price change decision is one of the most difficult decisions a manager has to take and the knowledge of the product price elasticity is important towards the correct decision(Thomas and Maurice, 2008, p. 204).
Price elasticity is important for businesses as it has has implications for setting prices of their goods services and it has an impact to the business total revenue. Businesses can use price elasticity of demand to maximize their revenue and as a result, their profits. For example a monopoly company can conclude that its peak period demand is inelastic and off peak period demand is elastic. So, the company can set higher prices in peak period, set low prices in off peak periods and use price discrimination to maximize revenue or yield. In addition, by considering the factors affecting the price elasticity of demand a business can determine to some extent the price elasticity of demand and enable to set prices on the basis of the price elasticity information in to consideration. Also, if a company knows that switching the cost affects the price elasticity of demand, by increasing the switching cost of their services they can make the demand inelastic charge higher prices because the customers will not be able to switch to other companies easily if switching costs are higher. Furthermore, companies that operate in a competitive environment can utilize price elasticity of demand to create a competitive advantage against the competitive products. As mentioned above, a competitive environment is a factor that increases the elasticity of the products. So, products in competitive environment are mainly elastic. As a result the businesses must consider the market structure because as explained above these factors affect the price elasticity of demand and it has impact on the yield level of the company.
Moving on, price elasticity is important tool that can be used for government decisions also. For example, the government must consider price elasticity of demand in imposing indirect taxes, because the imposition of taxes will increase the prices and it will affect the supply of products. So, if the products are elastic, the consumers will reduce their purchases more and as a result the price will increase due to the tax imposition. In such a case less tax will be paid than if the price elasticity of demand is inelastic. Using price elasticity of demand a government can conclude that it must not impose taxes on elastic goods because they may not be able to collect sufficient taxes compared to if they impose taxes on inelastic goods. In another example, governments impose taxes on cigarettes and alcohol. The demand of these products, which is dependent on habits than on price, is rather inelastic than elastic. Also, if a government is a monopoly supplier of any business services like rail or transport tolls it can charge higher prices in peak periods and low prices on off peak periods because the price elasticity of demand is inelastic in peak periods compared to off peak periods. Thus, governments can use the price discrimination strategy to maximize revenue. A government can also use the concept of price elasticity for other decisions and not only for maximizing income from taxes. So, in addition to the above, if a government realizes that a market is monopolistic in nature, it may introduce more competition and regulation of prices in order to protect customers from price maintenance practices and anti competitive practices by these monopolies. This way the market can become more competitive and therefore the demand can become elastic rather than inelastic. Another way of using price elasticity for pursuing policies is towards reduction of demand on several activities. For example, if a government wants to reduce gambling it can raise the taxes and reduce the demand.
Concluding, price elasticity of demand is an important tool for analyzing the implications of price changes to the demand of services and products. It can become very useful in the hands of businesses and governments towards the adoption of correct decisions and proper policies.

References
Kench, B.T (2008). Fundamentals of Economics. Ivy Software.
Thomas, C. A.,&Maurice, C. (2008). Managerial Economics. McGraw-Hill .