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Determinants of Price Elasticity of Demand | Goods | Economics

Determinants of Elasticity of Demand

❶Such as the higher range products are usually bought by the rich people, and they do not care much about the change in the price and hence the demand for such higher range commodities is said to be inelastic. Products whose production times take longer have relatively inelastic supply compared to those products where the production time is less.

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If one part of the supply chain grows, whereas the rest of the supply chain remains stagnant, the growth will be lopsided. This affects the elasticity of supply as well. Consider the case of agriculture. However, more production would mean more warehouses, more cold storages and even more transport vehicles.

If this related infrastructure does not grow, producers may have to willfully cut down their production to avoid wastage.

So, if the related infrastructure is easily scalable, then the supply of such a product will be highly elastic or else it will be inelastic. Storage capacity is not the only issue. The supplier also needs to consider whether or not the goods that they hold are perishable or not. Perishable goods have a limited shelf life and the buyers know it.

The buyers can wait for some time and producers will have to lower the prices or take the losses that arise from wastage. The supply of perishable goods is therefore highly elastic since whatever has been produced has to be disposed off at the earliest.

However, when it comes to non perishable goods it has been observed that the supply is usually inelastic since producers can hold on for as long as they have to.

They are under no immediate compulsion to sell and hence the supply is inelastic. Length of Production Period: The law of supply assumes that changes in price will produce an immediate effect in the quantity supplied.

This may be theoretically correct. However, this is not possible in reality for many products. Production is a time and resource consuming process. The demand for common salt, soap, matches and such other goods tends to be highly inelastic because the households spend only a fraction of their income on each of them. On the other hand, demand for cloth in a country like India tends to be elastic since households spend a good part of their income on clothing.

If the price of cloth falls, it will mean great saving in the budget of many households and therefore they will tend to increase the quantity demanded of the cloth. On the other hand, if the price of cloth rises many households will not afford to buy as much quantity of cloth as before, and therefore, the quantity demanded of cloth will fall. The greater the number of uses to which a commodity can be put, the greater will be its price elasticity of demand.

If the price of a commodity having several uses is very high, its demand will be small and it will be put to the most important uses and if the price of such a commodity falls it will be put to less important uses also and consequently its quantity demanded will rise significantly.

If its price rises to a very high level, it will be used only for essential purposes such as feeding the children and sick persons. If the price of milk falls, it would be devoted to other uses such as preparation of curd, cream, ghee and sweets.

Therefore, the demand for milk tends to be elastic. Complementarity between goods or joint demand for goods also affects the price elasticity of demand. Households are generally less sensitive to the changes in price of goods that are complementary with each other or which are jointly used as compared to those goods which have independent demand or used alone.

Now, if the price of lubricating oil goes up, it will mean a very small increase in the total cost of running the automobile, since the use of oil is much less as compared to other things such as petrol. Thus, the demand for lubricating oil tends to be inelastic. Similarly, the demand for common salt is inelastic, partly because consumers do not use it alone but along with other things. It is worth mentioning here that for assessing the elasticity of demand for a commodity all the above three factors must be taken into account.

The arc elasticity is defined mathematically as: This method for computing the price elasticity is also known as the "midpoints formula", because the average price and average quantity are the coordinates of the midpoint of the straight line between the two given points. However, because this formula implicitly assumes the section of the demand curve between those points is linear, the greater the curvature of the actual demand curve is over that range, the worse this approximation of its elasticity will be.

Together with the concept of an economic "elasticity" coefficient, Alfred Marshall is credited with defining PED "elasticity of demand" in his book Principles of Economics , published in If it is slow But if it is rapid, a small fall in price will cause only a very small increase in his purchases.

In the former case In the latter case The overriding factor in determining PED is the willingness and ability of consumers after a price change to postpone immediate consumption decisions concerning the good and to search for substitutes "wait and look". On a graph with both a demand curve and a marginal revenue curve, demand will be elastic at all quantities where marginal revenue is positive. Demand is unit elastic at the quantity where marginal revenue is zero.

Demand is inelastic at every quantity where marginal revenue is negative. A firm considering a price change must know what effect the change in price will have on total revenue. Revenue is simply the product of unit price times quantity:. Generally any change in price will have two effects: For inelastic goods, because of the inverse nature of the relationship between price and quantity demanded i.

But in determining whether to increase or decrease prices, a firm needs to know what the net effect will be.

Elasticity provides the answer: The percentage change in total revenue is approximately equal to the percentage change in quantity demanded plus the percentage change in price. One change will be positive, the other negative. As a result, the relationship between PED and total revenue can be described for any good: Hence, as the accompanying diagram shows, total revenue is maximized at the combination of price and quantity demanded where the elasticity of demand is unitary.

It is important to realize that price-elasticity of demand is not necessarily constant over all price ranges. The linear demand curve in the accompanying diagram illustrates that changes in price also change the elasticity: PEDs, in combination with price elasticity of supply PES , can be used to assess where the incidence or "burden" of a per-unit tax is falling or to predict where it will fall if the tax is imposed. For example, when demand is perfectly inelastic , by definition consumers have no alternative to purchasing the good or service if the price increases, so the quantity demanded would remain constant.

Hence, suppliers can increase the price by the full amount of the tax, and the consumer would end up paying the entirety. In the opposite case, when demand is perfectly elastic , by definition consumers have an infinite ability to switch to alternatives if the price increases, so they would stop buying the good or service in question completely—quantity demanded would fall to zero. As a result, firms cannot pass on any part of the tax by raising prices, so they would be forced to pay all of it themselves.

In practice, demand is likely to be only relatively elastic or relatively inelastic, that is, somewhere between the extreme cases of perfect elasticity or inelasticity. More generally, then, the higher the elasticity of demand compared to PES, the heavier the burden on producers; conversely, the more inelastic the demand compared to PES, the heavier the burden on consumers.

The general principle is that the party i. Among the most common applications of price elasticity is to determine prices that maximize revenue or profit. If one point elasticity is used to model demand changes over a finite range of prices, elasticity is implicitly assumed constant with respect to price over the finite price range.

The equation defining price elasticity for one product can be rewritten omitting secondary variables as a linear equation. Constant elasticities can predict optimal pricing only by computing point elasticities at several points, to determine the price at which point elasticity equals -1 or, for multiple products, the set of prices at which the point elasticity matrix is the negative identity matrix.

The fundamental equation for one product becomes. Excel models are available that compute constant elasticity, and use non-constant elasticity to estimate prices that optimize revenue or profit for one product [38] or several products.

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Definition: The Elasticity of Demand is a measure of sensitiveness of demand to the change in the price of the commodity. Determinants of Elasticity of Demand Apart from the price, there are sever Apart from price, there are several factors that influence the elasticity of demand.

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will use the cross elasticity of demand. One possible definition is: companies are in the same industry if the cross elasticity of demand is + or greater. This means that a 10% increase in the price of one product would cause the demand for the other product to rise by 10% or more.

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Price. The law of demand states that when prices rise, the quantity of demand falls. That also means that when prices drop, demand will grow. People base their purchasing decisions on price if all other things are equal. The exact quantity bought for each price level is described in the demand schedule. Whereas, if we were estimating the price elasticity of demand for all cars and time consumers have are the two critical determinants of price elasticity demand.

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• Determinants of Demand • How responsive is Demand to changes in price? in income? in prices of other goods? tastes? • Demographics and demand • Demand and Need SA Topic 2 Housing Demand, Supply and Price D = 1 unit elasticity If demand price is elastic. CHAPTER-4 Elasticity of Demand in any one of demand economist consider three important kinds of elasticity of demand like: (i) Price elasticity of demand The price elasticity of demand attempts to measure the relationship.