Define elasticity of demand and explain its importance for pricing.

• A. It tells producers how much to increase production when prices rise
• B. It is only relevant for luxury goods
• C. It measures how responsive quantity demanded is to price changes and affects revenue, pricing strategies, and tax incidence.
• D. It determines the number of substitutes in the market

Answer: (C)

Elasticity of demand tells us how much the quantity demanded will respond to a price change, usually measured as the percentage change in quantity demanded divided by the percentage change in price. This is crucial for pricing because it helps predict how a price move will affect total revenue. When demand is elastic, buyers are sensitive to price, so raising the price causes a relatively large drop in quantity and total revenue falls. When demand is inelastic, quantity doesn’t fall much as price rises, so total revenue tends to rise. Pricing strategies use this idea to set prices that balance volume and margin to achieve revenue goals. The concept also links to tax incidence: the less elastic side of the market bears more of the burden. Factors like the availability of substitutes, whether the product is a necessity or luxury, the share of income spent on the item, and the time buyers have to adjust all influence elasticity.