Resources | Subject Notes | Economics
This section explores the factors that influence the price elasticity of demand (PED), a crucial concept in microeconomics. PED measures the responsiveness of quantity demanded to a change in price. Understanding these factors is essential for businesses and policymakers alike.
Price elasticity of demand is calculated as:
$$PED = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}}$$
The magnitude of PED indicates the sensitivity of consumers to price changes:
Several factors influence how elastic or inelastic the demand for a good is. These factors can be broadly categorized into:
The availability of close substitutes is a primary determinant of PED. If many substitutes are available, consumers can easily switch to alternatives if the price of the original good increases, leading to elastic demand. Conversely, if few substitutes exist, demand will be more inelastic.
| Factor | Effect on PED |
|---|---|
| Many Substitutes | Elastic Demand |
| Few Substitutes | Inelastic Demand |
Necessities (e.g., food, medicine) tend to have inelastic demand because consumers need them regardless of price. Luxuries (e.g., expensive cars, designer clothes) typically have elastic demand because consumers can easily forgo them if prices rise.
The proportion of a consumer's income spent on a good also affects PED. Goods that represent a large proportion of income tend to have more elastic demand. A price increase in a high-proportion good has a greater impact on the consumer's budget, making them more likely to reduce consumption.
| Proportion of Income | Effect on PED |
|---|---|
| Large Proportion | Elastic Demand |
| Small Proportion | Inelastic Demand |
Demand tends to become more elastic over time. This is because consumers have more time to find substitutes or adjust their consumption habits. In the short run, demand might be inelastic as consumers are accustomed to the product. However, in the long run, they have more options.
The breadth of the market being considered affects PED. Demand for a specific brand of coffee might be more elastic than demand for coffee in general. The more narrowly defined the market, the more likely it is to be relatively elastic.
Goods with addictive properties (e.g., cigarettes, alcohol) often exhibit inelastic demand. Addicts are willing to pay a higher price to continue consuming the good, regardless of the price increase.
Understanding the factors that influence PED is crucial for businesses making pricing decisions and for policymakers considering the impact of taxes and regulations. The elasticity of demand is not constant and can vary depending on a range of consumer and market characteristics.