Factors Affecting Price Elasticity Of Demand Essay Examples

i. Nature of Goods:

Refers to one of the most important factors of determining the price elasticity of demand.

In economics goods are classified into three categories, namely, necessities (or essential goods), comforts, and luxuries.

Generally, the demand L essential goods, such as salt, sugar, match boxes, and soap, is relatively inelastic (less than unity) or perfectly inelastic.

This implies that consumers purchase the same quantity of these goods, regardless of increase or decrease in their prices. Moreover, the consumption of necessities cannot be postponed; therefore, the demand for necessities is inelastic. On the other hand, price elasticity of demand for luxury goods, such as car, air conditioners, and expensive jewellery, is highly elastic.

Any change in the prices of luxury goods cause a major a change in their demand. In addition, the price elasticity of demand for comforts, such as milk fan, and coolers, is equal to unity. Therefore, we can say that demand for comforts is more elastic as compared to necessities and less elastic than luxury goods. However, this statement is not always true as the demand for luxury goods may be elastic in lower and medium income groups, but can be inelastic in upper class.

Apart from this, goods are also grouped into durable and perishable goods. Durable goods, such as furniture car, and computer, are the goods that can be used number of times, while perishable goods, including eatables and cold drinks, have a single use. The price elasticity of demand for durable goods is more elastic as compared to perishable goods. The is because when the price of durable goods increases, consumers prefer to get the old ones repaired or replace them with pre-used ones.

ii. Availability of Substitutes:

Influences the elasticity of demand to a larger extent. The main reason for change in the elasticity of demand with change in price of some goods is the availability of their competing substitutes. The larger the number of close substitutes of a good available in the market, greater the elasticity for that good. For example, tea and coffee are close substitutes.

If the price of tea rises, consumers may curtail the consumption of tea and purchase coffee and versa. In such a case the demand for tea decreases, while demand for coffee increases. Therefore, the elasticity of demand for both of these goods would be higher. However, the demand for goods that do not have close substitutes, such as liquor, is inelastic, irrespective of increase or decrease in its price.

iii. Number of Uses of a Good:

Helps in determining the price elasticity of a good. The demand for multi-use goods is more elastic as compared to single-use goods. When the price of a multi-use good decreases, consumers would increase its consumption. Therefore, the percentage change in the demand for multi-use goods is more with respect to percentage change in their prices.

For example, electricity can be used for a number of purposes, such as lighting, cooking, and various commercial and industrial purposes. If the price of electricity decreases, consumers may increase its usage for various other purposes.

Similarly, if the price of milk decreases, consumers may increase its consumption by using it for various purposes, such as making curd, butter, cream, and ghee. In such a case, the demand for milk would be highly elastic. On the contrary, if the price for these goods increases, there use would be restricted to urgent purposes only.

iv. Distribution of Income:

Acts as a crucial factor in influencing the price elasticity of demand. If a consumer has high income, then the demand for products consumed by him/her would be inelastic. For example, an increase in prices of any product would not affect the demand for products consumed by a millionaire.

On the other hand, demand for products consumed by lower or middle income consumers would be highly sensitive to change in the price. For example, if the price of mobile phones increases, then the demand for mobile phones would be inelastic in high income group, whereas it would be highly elastic in lower and middle income group consumers.

v. Level of Price:

Refers to the fact that demand for high-priced goods, such as expensive gold and diamond jewellery and imported cars, is inelastic. The change in the price of these goods produces a very small change in their demand. Similarly, the demand for low-priced goods, such as cheap potatoes and match boxes, is also inelastic.

This is due to the fact that consumers have already purchased these goods in sample quantities; therefore, change in the price of these goods causes a little change in their demand. In the words of Marshall, “Elasticity of demand is great for high prices, and great or at least considerable for medium prices, but it declines as the price falls, and gradually fades away if the fall goes so far that satiety level is reached.”

Apart from this, the demand for medium-priced goods that are neither very costly nor very low cost is elastic. The demand for medium-priced goods is very sensitive to change in their prices.

vi. Proportion of Total Expenditure:

Refers to another important factor that determines the price elasticity of demand. If a consumer spends a large portion of his/her income to purchase a specific product, then the demand for that product would be elastic. On the contrary, the demand would be inelastic for products which are purchased after spending a small portion of consumers’ income.

For example, goods, such as salt, newspaper, toothpaste, matchboxes, pens, and books, entitle a small portion of consumer’s income. The demand for these goods is usually inelastic as increase in the price of these goods does not have major impact on consumer’s budget. Therefore, consumers continue to purchase the same quantity of these goods even in case of increase in their prices.

vii. Time Factor:

Implies that the price elasticity of demand largely depends on time that consumers take to adjust themselves with new prices of a product. The longer the period of time, higher the price elasticity of demand. This is due to the fact that over a period of time, consumers get adjusted to change in prices or new prices.

For example, if the price of petrol decreases, then it would not result in immediate increase in its demand until consumers have purchasing power to buy vehicles. However, over a period of time, consumers might be able to adjust their expenditure and consumption patterns, so that they can purchase vehicles spurred by fall in the prices of petrol. Therefore, we can say that fall in the price of products, would expand their demand in the long run.

viii. Complementary Goods:

Refer to the fact that the demand for complementary goods is relatively inelastic. The complementary goods, pen and ink and car and petrol, are consumed jointly. Therefore, the rise in price of one good would not affect its demand, until there is change in the price of its complementary good. For example, if the price of petrol rises, then its demand would not contract immediately until the price of car increases.

ix. Possibility of Postponement:

Implies that goods whose demand can be postponed by consumers to a near future, then the demand would be highly elastic. For example, purchasing a car and renovating a building can be postponed; therefore, their demand is highly elastic. On the other hand, if the demand for a particular product cannot be postponed, then its demand would be inelastic. For example, demand for medicines is inelastic.

Some of the major factors affecting the elasticity of demand of a commodity are as follows:

A change in price does not always lead to the same proportionate change in demand. For example, a small change in price of AC may affect its demand to a considerable extent/whereas, large change in price of salt may not affect its demand. So, elasticity of demand is different for different goods.

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Various factors which affect the elasticity of demand of a commodity are:

1. Nature of commodity:

Elasticity of demand of a commodity is influenced by its nature. A commodity for a person may be a necessity, a comfort or a luxury.

i. When a commodity is a necessity like food grains, vegetables, medicines, etc., its demand is generally inelastic as it is required for human survival and its demand does not fluctuate much with change in price.

ii. When a commodity is a comfort like fan, refrigerator, etc., its demand is generally elastic as consumer can postpone its consumption.

iii. When a commodity is a luxury like AC, DVD player, etc., its demand is generally more elastic as compared to demand for comforts.

iv. The term ‘luxury’ is a relative term as any item (like AC), may be a luxury for a poor person but a necessity for a rich person.

2. Availability of substitutes:

Demand for a commodity with large number of substitutes will be more elastic. The reason is that even a small rise in its prices will induce the buyers to go for its substitutes. For example, a rise in the price of Pepsi encourages buyers to buy Coke and vice-versa.

Thus, availability of close substitutes makes the demand sensitive to change in the prices. On the other hand, commodities with few or no substitutes like wheat and salt have less price elasticity of demand.

3. Income Level:

Elasticity of demand for any commodity is generally less for higher income level groups in comparison to people with low incomes. It happens 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.

4. Level of price:

Level of price also affects the price elasticity of demand. Costly goods like laptop, Plasma 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 change in prices of such goods do not change their demand by a considerable amount.

5. Postponement of Consumption:

Commodities like biscuits, soft drinks, etc. whose demand is not urgent, have highly elastic demand as their consumption can be postponed in case of an increase in their prices. However, commodities with urgent demand like life saving drugs, have inelastic demand because of their immediate requirement.

6. Number of Uses:

If the commodity under consideration has several uses, then its demand will be elastic. When price of such a commodity increases, then it is generally put to only more urgent uses and, as a result, its demand falls. When the prices fall, then it is used for satisfying even less urgent needs and demand rises.

For example, electricity is a multiple-use commodity. Fall in its price will result in substantial increase in its demand, particularly in those uses (like AC, Heat convector, etc.), where it was not employed formerly due to its high price. On the other hand, a commodity with no or few alternative uses has less elastic demand.

7. Share in Total Expenditure:

Proportion of consumer’s income that is spent on a particular commodity also influences the elasticity of demand for it. Greater the proportion of income spent on the commodity, more is the elasticity of demand for it and vice-versa.

Demand for goods like salt, needle, soap, match box, etc. tends to be inelastic as consumers spend a small proportion of their income on such goods. When prices of such goods change, consumers continue to purchase almost the same quantity of these goods. However, if the proportion of income spent on a commodity is large, then demand for such a commodity will be elastic.

8. Time Period:

Price elasticity of demand is always related to a period of time. It can be a day, a week, a month, a year or a period of several years. Elasticity of demand varies directly with the time period. Demand is generally inelastic in the short period.

It happens because consumers find it difficult to change their habits, in the short period, in order to respond to a change in the price of the given commodity. However, demand is more elastic in long rim as it is comparatively easier to shift to other substitutes, if the price of the given commodity rises.

9. Habits:

Commodities, which have become habitual necessities for the consumers, have less elastic demand. It happens because such a commodity becomes a necessity for the consumer and he continues to purchase it even if its price rises. Alcohol, tobacco, cigarettes, etc. are some examples of habit forming commodities.

Finally it can be concluded that elasticity of demand for a commodity is affected by number of factors. However, it is difficult to say, which particular factor or combination of factors determines the elasticity. It all depends upon circumstances of each case.

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