Factors affecting Price Elasticity of Demand

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Learning Contents: 

·        Factors affecting Price Elasticity of Demand /Determinants of Price Elasticity of Demand


Factors affecting Price Elasticity of Demand

There are several factors that explain the reasons whether the demand is elastic or not. The price elasticity of demand depends on various factors such as the nature of goods, availability of substitutes, consumer habits, consumer’s income, and so on. The brief description of such factors that affect the price elasticity of demand is as follows:

1.      Nature of Goods

Necessary goods such as fuel, electricity, water, medicines, etc. tend to have inelastic demand. Their consumption cannot be cut off even if their price increases as they are the essentials of our life. On the other hand, Luxury goods such as food, entertainment, furniture, etc. tend to have relatively elastic demand because their consumption can easily be cut off when time goes tough. Hence, Necessary goods have less elastic demand as compared to luxury goods.

2.      Availability of substitutes

Substitute goods usually have elastic demand as consumers have options to switch to the other goods if the price changes. Generally, consumers have the tendency to look for cheaper substitutes when the price of goods increases. Suppose, for example, that the price of a Tata car goes up. There are many close substitutes for Tata- Maruti, Hyundai, Ford, and so on. Due to the availability of its substitutes, its demand becomes more elastic. On the other hand, Demand for goods with no substitutes such as liquor, cigarettes, etc. is found to be inelastic or less elastic.

3.      Proportion of Income spent on a commodity/ Importance in Household Budget

Elasticity of demand also depends on the amount of income a consumer spends on the different commodities. Goods on which a consumer spends a very small part of his income tend to have inelastic demand. For example, a change in the price of pencils, newspapers, toothpaste, etc. will not affect their demand as they constitute a very small part of the consumer’s budget and therefore, their demand will be inelastic or less elastic. On the other hand, Goods on which a consumer spends a large part of his income tend to have elastic demand as they constitute a large part of the consumer’s budget. For example, a change in the price of cars, clothes, appliances, etc. will affect the consumer’s budget and therefore demand will be more elastic.

4.      Habit of consumers

Generally, consumers who become habitual of using a particular good or service don’t care about the rise or fall in the price. Since their habits are difficult to break, so they continue to buy them as before even if the price is changed. For example, a person who has a habit of consuming liquor will not stop consuming it even its price is increased. Therefore, the elasticity of demand is inelastic or less than unitary elastic in the case of habitual goods.

5.      Income Level of the Buyer

The elasticity of demand also depends on the income level of the consumer. Consumers with a high level of income are not bothered by the changed price of goods and services. In other words, the demand for their goods and services continues to remain the same as before even if the price increases or decreases. Hence, the demand is inelastic or less elastic. On the other hand, consumers with a low level of income are greatly influenced by the changed price of goods and services and they often postpone their purchase and hence the demand is highly affected or remains more elastic. For e.g. A middle-class consumer might postpone the purchase of home appliances if their price increases.

6.      Postponement of Use

Goods that are considered luxuries or whose purchase can be easily postponed usually have elastic demand as they will not affect much our daily life activities. For example, a consumer who is planning to buy a car might postpone or delay its purchase due to increased price. On the other hand, Goods that are considered to be essentials such as food, medicine, etc. have inelastic demand as their purchase cannot be delayed.

7.      Time Period

Demand tends to be less elastic or inelastic in the short- run as consumers don’t get enough time to look for the cheaper alternatives and continue to buy the same even if price changes. On the other hand, Demand is more elastic in the long- run as consumers get enough time to look for the different alternatives and buy the cheaper ones.

8.      Diversity of Uses

Goods with multiple uses often have elastic demand as price change can restrict its usage to limited purposes. For example, Milk can be used for drinking, making sweets, Curd, Buttermilk, Cheese, etc. If its price increases, consumers will use it for limited purposes or stop for other uses. Therefore, its demand will be elastic. On the other hand, goods such as textbooks or other stationery items usually have inelastic demand as they have very limited uses.


Let’s try some questions

Choose the Correct Answer

1. The demand for sugar and tea is usually:

a. Elastic

b. Inelastic

c. Perfectly Elastic

d. All of Above.

2. Elasticity of demand is greater than unity for?

a. Necessaries

b. Luxuries

c. Comforts

d. Complementary goods

3. Which of the following is the example of elastic demand?

a. Housing

b. Furniture

c. Cars

d. All of Above.

4. Availability of close substitutes makes the demand.

a. less elastic  

b. more elastic

c. Parallel to X-axis

d. Parallel to Y-axis

5. Of the following, demand is likely to be the least elastic for

a. Automobile  

b. Electronic Appliance

c. Precious stone

d. Toothpaste

6. The demand for food is most elastic in countries

a. with low-income levels

b. highly urbanized

c. with intermediate income levels

d. with high-income levels

7. A university decides to raise tuition fees to increase the total revenue it receives from students. This strategy will work if the demand for education at that university is:

a. Elastic

b. Inelastic

c. Perfectly elastic

d. Unitary elastic

 

8. The price elasticity of demand generally tends to be:

a. smaller in the long run than in the short-run

b. smaller in the short run than in the long-run

c. larger in the short run than in the long-run

d. unrelated to the length of time.

 

Answer Key

 

1.b

2.b

3.d

7. b

4.b

5.d

6.a

8. b


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