Determining Factors of Price Elasticity of Demand
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Elasticity of Demand
The elasticity of demand is a measure of degree of responsiveness of quantity demanded for a product to the change in its determinants.
The law of demand helps to understand the direction in which price and quantity demanded change.
It is limited to the statement as:
If price increases, quantity demanded will decline or if income rises demand will increase.
But it cannot answer by how much?
In business or economic analysis, it is essential to address ‘by how much’ question.
It is necessary to find out the exact value of the change in quantity demanded in response to the change in price or income.
Elasticity of demand helps to find out the exact values in such cases.
The elasticity of demand is a measure of degree of responsiveness of demand for a product to the change in its determinants.
Elasticity of demand (Ep) = Percentage change in quantity demand for a good ÷ Percentage change in its price
Demand is determined by various factors such as price, income, price of other goods, taste, preferences etc.
There are various types of elasticity of demand as its determinants.
However, we discuss only price, income and cross elasticity of demand as they are the main determinants of demand whose change is visible and measurable.
Types of Elasticity of Demand
There are three types of elasticity of demand. They are
Determining Factors of Price Elasticity of Demand
The responsible factors which bring the variation in the elasticity of demand are known as determinants of elasticity of demand.
The price elasticity of demand varies from goods to goods, time to time, place to place and person to person.
There are various responsible factors for the variation in the elasticity of demand.
Out of them, some are explained below:
Availability of substitutes
Good with close substitutes tend to have more elastic demand than less or no substitutes.
Because, it is easier for consumer to switch from one product to others.
For example Coca-Cola and Pepsi are easily substitutable.
A small increase in price of Coca-Cola causes to the increase in the quantity demand of Pepsi in a large quantity (if other things constant and brand ignored)
On the other, rice is food without a close substitute the demand for rice is less elastic compare with demand for Coca-Cola.
Income level
Elasticity of demand is depended on income level of the customers.
For higher level income customers, elasticity of demand is less influence comparison to low income customers.
Because, rich people are not influenced much by changes in the price of goods.
But, poor people are highly affected by increase or decrease in the price of goods.
As a result, demand for lower income group is highly elastic.
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Price level
Price level of the goods also affects the price elasticity of demand.
Costly goods like laptop, LED TV etc have highly elastic demand as their demand is very sensitive to changes in their prices.
However, demand for inexpensive goods like needle, match box etc is inelastic as changes in prices of such goods do not change their demand by a considerable quantity.
Consumption postponed
Goods like biscuits, soft drinks etc whose demand is not, they have highly elastic demand.
Their consumption can be postponed in case of an increase in their prices.
However, goods with urgent demand like lifesaving drugs have inelastic demand because of their immediate requirement.
Luxuries vs. necessities
The demand for necessities tends to be inelastic; the demand for luxuries tends to be elastic.
Generally, bread (food) and electricity (light) are regarded as necessities; we cannot live without them.
A price increase will not reduce significantly the amount of bread consumed.
On the other hand, diamond, iPhone and automobiles are luxuries; they can be forgone without undue inconvenience.
If the price of diamond or iPhone rises, customer does not need to purchase; customer will not face great difficulty.
Time period
Price elasticity of demand is always related to a period of time; and time may be a day, a week, a month, a year or a period of several years.
Elasticity of demand varies directly with the time period.
Generally, demand is inelastic in the short period.
Because, consumers find it difficult to change or substitute goods in the short period.
If price of LPG (fuel gas) increases highly, it may be default to substitute in short period but consumers can use induction stove if electricity is cheap.
Proportion of income
Elasticity of demand of a good is also determined by the percentage of income of a purchaser.
Other things being equal, the larger is the proportion of one’s budget on a good, the greater will tend to be the elasticity of demand for it.
A 20% increase in the price of pencils or chewing gum will effect little changes in demand.
But 10% increase in the price of automobiles or housing means price increases are significant fractions of the annual incomes of many families.
Habits
Commodities, which have become
Habitual goods and commodities have less elasticity of demand.
Because, such habitual commodity becomes a necessity for the consumer and he continues to purchase it even if its price rises.
Cigarettes, alcohol, tobacco etc are some examples of habit forming commodities.
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