Determinants of price elasticity of demand

examples of inelastic goods

electricity, vaccines, medication, water

examples of elastic goods

milk, maccas

Determinants of price elasticity of demand

The availability of substitutes, Whether the good is a necessity or a luxury or addictive, Definition of the market, The proportion of income spent on the product, Time available to respond

The availability of substitutes

** The greater the number of close substitutes a good has, the more price elastic its demand. If the price of good X rises and it has many close substitutes, then consumers will be sensitive to the price change because they can easily switch to other products. If price of good x rises and it has few substitutes (food/water) it is very inelastic.

Whether the good is a necessity or a luxury or addictive

necessities (e.g. bread, milk, rice are essential food groups, petrol and water) are more price inelastic than luxury goods such as jewelry and hang bags. Habit forming and addictive goods such as tobacco and alcohol are highly price inelastic because they are perceived as necessities by people who use them.

Definition of the market

The demand for a good in a broadly defined market will be more inelastic than the demand for a good in a narrowly defined market. e.g. petrol is a broadly defined market whereas a particular *brand* of petrol is a narrowly defined market. The demand for a specific brand such as BP, Coles Express or Caltex, would be very elastic because each brand acts as a very close substitute. This is different from the price elasticity of demand for petrol in general. for all goods, the price elasticity of a brand is greater than the price elasticity of the good in general.

The proportion of income spent on the product

inexpensive items will be relatively price inelastic vs. Expensive goods are likely to be relatively price elastic, because they take up a larger proportion of a consumer's income or budget.

Example of proportion of income spent on the product

if the price of a coffee increased from $4 to $5 (a 25% increase), it is unlikely to cause a significant decrease in the quantity demanded of coffee. However, if the price of a large screen television were to increase by 25% (from $2000 to $2500) we would expect this price increase to have a greater proportional effect on quantity demanded since it’d take a bigger proportion of income spent on the product.

Time available to respond

In the short run demand is relatively inelastic because consumers do not have the time to adjust their consumption or find substitute products. As the time period increases it becomes easier to change consumption patterns and so demand becomes more elastic.

Example of time available to respond

If petrol prices jump to very high levels, most consumers cannot change their consumption in the short run - they still have to fill their tank in order to drive to work. But if the price of petrol remains high over a longer period, then people will be able respond and adjust their consumption by using public transport or switching to electric or hybrid cars.