Factors Determining Price Elasticity Of Demand For A Good

Introduction

Although price and demand are related, a change in price does not always result in a proportionate change in demand.

For example, even a slight change in the prices of Refrigerators may affect the demand while a large change in the prices of salt may not change the overall demand.

What is Price Elasticity of Demand?

Price elasticity of demand is an important economic indicator of the growth in the demand of quantity or consumption of a commodity in relation to its change in price.

Economists generally use price elasticity to express how supply or demand changes in the economy. It is also used to understand the workings of the real economy, due to and despite price changes.

For example, some goods have rather inelastic demand. That is, their prices don't change substantially with the changes in demand or supply.

For example, people need to buy fuel to get to work or roam around the world. Even if oil prices increase, people will purchase the same amount of gas still. So, there will be no change in consumption and the process will be inelastic in demand.

On the other hand, some commodities are very dynamic in changes in demand, causing drastic changes in their demand or supply due to the increase or decrease of price.

Factors Affecting Elasticity of Demand

Some of the factors that affect the elasticity of demand are the following −

Nature of Commodity

As commodities may be a necessity, comfort, or luxury, their elasticity may be influenced by the nature of the commodities.

• The demand for necessities is generally inelastic to the price because demand does not change with the changes in price. Examples of commodities that have inelastic demand include medicines, food grains, vegetables, etc.
• For comfort commodities like fans, refrigerators, etc, the demand is usually elastic because the consumption of the products may be postponed.
• The elasticity of demand for the object that is luxury is more than comfort commodities as they can sometimes not be bought and used. An example of a luxury commodity includes ACs.

Availability of Substitutes

A commodity that has more substitutes has more price elasticity of demand because consumers have the option of choosing more substitutes when the price of one commodity goes up.

For example, when Coca-Cola's price increases, people may opt Pepsi and vice versa.

Commodities that have fewer substitutes are usually inelastic in demand because people do not have choices to change options due to price changes.

For example, salt and wheat.

Level of Income

The price elasticity of demand for lower income groups is more for lower income groups than for higher income groups. This happens because the higher income group is less affected by changes in price, but the lower income group is affected more adversely due to changes in price.

Therefore, the demand for the lower-income groups is highly elastic.

Price Level

Price levels are also a major determinant of the elasticity of demand. Items with a higher price level have a higher elasticity of demand because a little change in their pricing affects the sale of the items. On the other hand, the elasticity of demand is less for lower-priced items.

For example, the elasticity of demand for Plasma TVs is more than that of matchboxes or needles.

Postponement of Date of Consumption

The elasticity of demand for goods the consumption of which may be postponed for a long time is higher than goods that have urgent needs of instant consumption.

For example, the elasticity of demand for biscuits is more than the elasticity of demand for life-saving drugs. In this case, the consumption of biscuits can be postponed for a considerably long time, but drugs must be consumed within a shorter period of time.

Number of Uses

The commodities or services that have a higher number of uses have more elasticity in demand. In these cases, the goods and services can be used for more alternative cases. So, their demand is more elastic than items that have fewer uses.

When the price of such an item increases it is used in fewer cases leading to a fall in demand. When the price goes down, the use goes up leading to more demand.

An example of such an item is electricity which is used more when its unit price goes down but used less when its price is higher. In general, electricity is used more via ACs, Ovens, Convectors, etc when its price is low but when the price increases, these uses are restricted. So, items with more number of uses are more elastic in nature.

Proportion of Expenditure Spent on Items

The proportion of total expenditure spent on items will also affect the elasticity of demand. When the proportion of expenditure spent is higher, the elasticity of demand will also be higher.

For example, demand for needles and match boxes tends to remain constant even when prices change because only a smaller portion of the total expenditure is spent on them. As the prices consume more proportion of income, the demand tends to be more inelastic.

Period of Time

The time period is directly related to the elasticity of demand. Usually, the elasticity of demand is lower in the case of shorter time periods. With increasing time, the elasticity of demand goes up.

The period of time may be calculated as hourly, daily, weekly, monthly, and so on. As we move to longer time periods, the price elasticity of demand increases. The reason for this is that when the time period is low, consumers have less time to change their choices. So, the demand for a product stays intact.

However, when the time period gets longer, consumers have more time to look for substitutes when the price changes. Due to this reason, the elasticity of demand goes up with increasing time periods.

Habits

Commodities that are habitual in nature have less elastic demands. The commodities that are habitual are consumed even if their prices go up. People are addicted to some commodities that turn into their habits and they will consume these items even if the prices of these items go up substantially.

Examples of such items include cigarettes, tobacco, etc. An increase in the prices of such items will not deter people from using them. Instead, they may even consume more of these commodities even when the price of the items goes up. Therefore, they have less elastic demand.

Conclusion

The price elasticity of demand is a critical factor in determining the exact demand for a product due to price changes. It shows the overall changes and lets economists determine the probable demand in the economy.

Marketers can use this to ascertain the probable demand that may be important for them to calculate. Therefore, it is a very useful tool for carrying out special measurements related to the demand and supply of commodities and hence the power of an economy.

FAQs

Qns 1. What does the price elasticity of demand indicate?

Ans. The price elasticity of demand indicates the change in demand due to a given change in the price of the product.

Qns 2. Name three factors on which price elasticity of demand is dependent.

Ans. The nature of the commodity, availability of substitutes, and level of income are three variables on which the price elasticity of demand is dependent.

Qns 3. Why is demand inelastic in the case of habitual products?

Ans People would not respond to price changes and continue consuming habitual products. So, the demand for habitual products is inelastic.