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Factors affecting price elasticity of demand essay

Factors Affecting the Price Elasticity of Demand | Economics

The following points highlight the seven main factors affecting the price elasticity of demand. The factors are: 1. Nature of the Good 2. Availability of Substitute Goods 3. Number and Variety of Uses of the Product 4. Proportion of Income Spent on the Good 5. Role of Habits 6. Possibility of Deferment of Consumption 7. Price of the Good.

Factor # 1. Nature of the Good:

The elasticity of demand for a good depends upon the nature of the good, i.e., whether the good is a necessary or a luxury good. The elasticity of demand for a necessary good is relatively small. For example, if the price of such a good rises, its buyers generally are not able to reduce its demand.

Again, if the price of a necessary good diminishes, the buyers cannot considerably increase their purchase of the good, since the good is a necessity, they had been purchasing the required quantities at the previous price. For example, rice is very much a necessary good to us, and so its demand cannot be reduced considerably when its price rises.

On the other hand, when its price falls its demand do not considerably increase because it had already been purchasing (at the previous price) almost all that it needed, since it is a necessity to us. Therefore, the more necessary a good is to us, the less would be its price-elasticity of demand.

But, elasticity of demand for a luxury good is generally high. This is because the consump­tion of a luxury good, unlike that of a necessary commodity, can be deferred. That is why if the price of such a good increases, the demand for the good can be considerably reduced.

On the other hand, if the price of a luxury good diminishes, the demand for the good would consider­ably increase, since, along with new demand, all deferred demands would now be satisfied. Therefore, demand for luxury goods would be relatively more elastic.

Factor # 2. Availability of Substitute Goods:

If close substitutes for a particular good are available in the market, then the demand for the good would be relatively more elastic. For example, since tea, a close substitute for coffee, is available in the market, a rise in the price of coffee would result in a considerable fall in its demand and a consequent rise in the demand for tea.

Therefore, demand for coffee would be relatively more elastic because of the availability of tea.

Again, conversely, if the price of coffee decreases, then people might reduce their consumption of tea and they might considerably increase their use of coffee. Therefore, the de­mand for coffee would be relatively more elastic, since its close substitute, viz., tea, is available in the market.

Again, since egg and meat are available in the market as close substitutes for fish, demand for fish would be relatively more elastic. It may concluded that the more the number of close substitutes for a particular good, the more would be the price-elasticity of demand for the good.

Factor # 3. Number and Variety of Uses of the Product:

The more the number and variety of uses of a good, the more would be its elasticity of demand. One such good is electricity that is used in a number of ways. For example, use of electricity for the purposes of lighting, heating, cooking, ironing and also use electricity as a source of power in industries.

That is why when the price of electricity diminishes (increases), its demand will increase (decrease) in all these uses, and so, in totality, its demand will increase (decrease) considerably, giving us a high value of the (numerical) coefficient of price-elasticity of demand.

Factor # 4. Proportion of Income Spent on the Good:

The price-elasticity of demand for a good also depends on the proportion of their income the buyers spend on the good. If the buyers spend a small proportion of their income, then they would not considerably decrease their purchase of the good as its price increases.

On the other hand, since the buyers spend a small proportion of their income on the good, they buy the good more or less according to their requirement at any particular price. Therefore, when the price of the good decreases, they do not considerably increase their purchase.

It is concluded then that if the buyers spend a small proportion of their income on a good, then its price-elasticity of demand would be relatively small. On the other hand, if they spend a large proportion of their income on a good, then its elasticity of demand would be relatively high. That is, elasticity of demand for a good depends upon the proportion of income spent on the good.

Factor # 5. Role of Habits:

The habits of people also play an important role in determining the extent of the elasticity of demand for a good. Sometimes some people completely surrender to the consumption of articles of addiction like drugs, alcohol and tobacco products. Consequently, if the prices of these goods increase, demand for them do not decreases considerably and so their elasticity of demand will be relatively small.

Factor # 6. Possibility of Deferment of Consumption:

if the buyers are able to defer the purchase or consumption of a good, if required, then it would have a relatively high elasticity of demand. For, if its price rises, its purchase would be deferred and its demand would fall, and if its price falls the deferred demand would appear in its market. The examples of such a good are building materials like cement, iron rods, etc.

Factor # 7. Price of the Good:

The elasticity of demand for a good also depends on its own price. As price changes, quantity demanded of the good changes, owing to the law of demand. Also, at different prices of the product, i.e., at different points on the demand curve for a good, the coefficient of price-elasticity of demand for the good would be different.

Generally, the smaller the price of a good, the less is the elasticity of its demand. For, when the price is very small, a change in price would have no considerable effect on demand.

On the other hand, the larger the price, the more would be the elasticity of demand. For, when the price is relatively large, a further rise in price would have a considerable dampening effect on de­mand and a fall in price would have an encouraging effect on demand.

9 Major Factors which Affects the Elasticity of Demand of a Commodity | Economics

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.