A comprehensive overview of the price elasticity of demand
If you have paid attention in high school, you may remember your teacher talking about the topic of economics known as elasticity. This theory is related to the demand and supply of products and services. This theory is known to be quite intricate, and it is quite common for students to struggle with it.
Now, if you have already grasped the whole concept of elasticity, then you are off to a great start. If you are not quite clued into what this whole thing is about, then don’t worry, you’re not far behind.
Presented below is an in-depth discussion on the price elasticity of demand, which will help you to gain clarity.
Definition of Price Elasticity of Demand
Price elasticity of demand is a parameter of the change in the quantity purchased or demanded of a product depending on its price change. This theory of economics is used by marketers to discover how the fluctuations in supply or demand changes in connection to the price to decipher the workings of the real economy.
For instance, some products tend to be inelastic (their prices don't change considerably in keeping with the changes in supply or demand). Now, let’s assume people need to buy gasoline to go to work or travel around the world, and so if the prices of oil go up, it's likely that people are still going to buy just the same amount of gas. On the contrary, several products are quite elastic, which means price fluctuations cause significant changes in both demand and supply.
Factors Influencing the Price Elasticity of Demand
Some of the defining factors that affect the price elasticity of demand are discussed below.
- Nature of the commodities:
The nature of the commodities has a significant role in determining the elasticity of demand. A commodity for an individual may be a comfort, a necessity, or a luxury.
- When a commodity is categorised as comfort like a fan, a refrigerator, etc., its demand is elastic as consumers can postpone its consumption.
- When a commodity is classified as a necessity, like medicines, vegetables, etc., its demand tends to be inelastic because it is necessary for human survival. Its demand doesn’t fluctuate too much with the change in price.
- When a commodity is a luxury like a DVD player or AC, its demand is typically more elastic as opposed to the demand for comforts. The term ‘luxury’ happens to be relative to any product. For example, an AC may be a luxury for a person with lower income but it is a necessity for a rich person.
The price elasticity of demand for any product is ideally less in the case of higher-income level groups as opposed to people with low incomes. It occurs because rich people are not affected much by the differences in the price of goods. But, poor people are mostly affected by the increase or decrease in the price of products. This is why the demand for the lower-income category is highly elastic.
- Delay in the consumption of commodities
Commodities like soft drinks, ice cream, etc. whose demand isn’t immediate, tend to have highly elastic demand as their consumption can be delayed in case of a rise in prices. However, products with urgent demand like lifesaving medicines have inelastic demand owing to their immediate requirements.
- Availability of alternatives
Demand for a commodity with a huge number of alternatives is generally more elastic. The reason behind this is that even a little increase in its prices will influence the consumers to go for the substitutes. For instance, an increase in the price of Pepsi encourages consumers to buy Coke or vice-versa.
Thus, the availability of similar products makes the demand more sensitive to fluctuations in the prices. On the other hand, products with a limited number of alternatives like salt or wheat have a lower price elasticity of demand.
Some products that have become habitual necessities for people who have less elastic demand. This is because the consumers continue to purchase the products even when the price escalates. Tobacco, alcohol, cigarettes, etc. are some of the pertinent examples of habit-forming commodities.
Price elasticity of demand is connected with a specific timeframe. It can be a day, a week, a month, a year or even several years in a row. The elasticity of demand differs directly, depending on the time span. The demand tends to be inelastic in a short period.
This is because the consumers find it hard to change their habits in a short span. However, the demand is more elastic in the long run as it is comparatively easier to shift to other alternatives if the price of the given goods escalates.
Types of Price Elasticity of Demand
Perfectly Elastic Demand (EP = ∞)
The demand is considered as perfectly elastic if the required quantity increases infinitely (or by unlimited quantity) with a small drop in price or the quantity demanded slips to zero with a little rise in the price. Hence, it is also known as infinite elasticity. It doesn’t have practical importance as it rarely occurs in real life.
Perfectly Inelastic Demand (EP = 0)
The demand is identified as perfectly price inelastic if the demand tends to be constant irrespective of the fluctuations in prices (i.e. price may rise or fall). This is why it’s also referred to as zero elasticity. It also doesn’t have practical importance as it’s rarely used in real life.
Relatively Elastic Demand (EP> 1)
The demand is considered relatively elastic if the percentage change in demand is more substantial than the percentage change in price. This implies that if there is a significant change in demand, there is a little change in price. It is also identified as highly elastic demand or simply elastic demand.
For instance, if the price drops by 5% and the demand increases by more than 5% (suppose 10%), then it is a case of elastic demand. The demand for luxury products like television, furniture, car, etc. is said to be elastic.
Relatively Inelastic Demand (Ep< 1)
The demand is recognised as relatively inelastic when the percentage change in quantity demanded is lower than the percentage change in the price. In this case, there would be a little change in demand with a significant change in price. It is also identified as simply inelastic or less elastic demand.
For instance, when the price drops by 10% and the demand escalate by less than 10% (say 5%), then it’s a case of inelastic demand. The demand for products of daily consumption like salt, rice, gasoline, etc. is considered to be inelastic.
Unitary Elastic Demand (Ep= 1)
The demand happens to be unitary elastic when the percentage change in quantity demanded is equal to the percentage change in price. It is also known as unitary elasticity. In this kind of demand, 1% change in price results in exactly 1% change in quantity demanded. This kind of demand tends to be an imaginary one as it’s rarely applicable in our practical life.
Price Elasticity Demand Calculator and Formula
The following PED formula is used to calculate the elasticity of demand.
Price elasticity of demand = % change in quantity demanded/ % change in Price
To measure the percentage, you need to divide the change in quantity by initial quantity. Therefore, if the price increases from $50 to $70, we divide 20/50 = 0.4 = 40%
Price elasticity of demand examples
- Examples of price inelastic demand
Petrol: It has some alternatives since people with a car have to buy petrol. Even though there are substitutes like a train, bus, etc., those aren’t as effective. When the price of petrol goes up, the demand proves to be quite inelastic.
Diamonds: This is a luxury item bought rather infrequently. You could purchase other precious gems as alternatives, but others may not have a similar appeal as diamonds. A cut in price wouldn’t increase demand very much.
Cigarettes: If cigarette tax goes up and the price of tobacco rises, the demand will be inelastic since many smokers are addicted and don’t have any alternatives to buy.
Examples of Price Elasticity of Demand
Different brands of soda, snacks or chocolates
These items tend to be discretionary, bought frequently, with many alternatives. If the price of a particular brand of snacks or chocolate goes up, the demand will be reduced as consumers will choose the less expensive alternatives.
Recreational air travel is not vital but discretionary. It is also quite expensive, and there are many competitors vying for the consumer’s attention. Increased prices will reduce the demand considerably, and lesser prices will raise demand.
The Significance of Price Elasticity of Demand
Price elasticity of demand is a prevalent concept in the field of economics and marketing. Now, leaf through the following pointers to gain clarity over its significance:
1. The development of government policies
The theory of price elasticity of demand is significant for creating government policies, specifically, the policies related to taxation. The government can levy higher taxes on products with inelastic demand, while low rates of taxes are levied on products with elastic demand.
2. International trade
In order to determine the prices of products to be exported, it is vital to have a clear understanding of the elasticity of demand for those products.
A country may impose higher prices for the products with inelastic demand. However, if demand for these items in the importing country tends to be elastic, then the exporting country will have to impose lower prices.
3. Significance of factor pricing
Price elasticity of demand is useful in deciding the amount to be paid to the factors of production. The factor with an inelastic demand can have a higher price as opposed to a factor with relatively elastic demand.
This allows the trade unions to understand the places where they can get an increase in the wage rate. The bargaining opportunity of trade unions relies on the elasticity of demand for workers services.
4. Pricing of the joint supply products
The items that are produced by a single production process are known as joint supply products. The expense of the production of these items is also joint. So, the elasticity of demand is considered while determining their prices.
The price of a joint supply tends to be high if its demand is inelastic.
5. Transferring the tax burden
Manufacturers transfer the burden of indirect tax to the buyers by maximizing the price of the product. The percentage relies on the degree of the elasticity of demand.
If the demand is inelastic, a significant part of indirect tax can be imposed on the consumers by increasing the price. On the contrary, if the demand tends to be elastic, then the burden of the tax will be more on the manufacturer.
6. Price discrimination
Price discrimination is basically an act of selling the same products at different prices to a different category of consumers. The practice of price-discrimination is lucrative to the monopolist when the elasticity of demand for the services or goods is different in various sub-markets.
In this case. The consumers whose demand is inelastic can be imposed at a higher price than the ones with more elastic demand.
Now that you have gone through the elaborate description of the price elasticity of demand, you will have no trouble preparing your academic paper or taking a test. This way, your academic prosperity will only elevate in the right direction.
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