Which are the determinants of the price elasticity? Explain in brief.

The determinants of the price elasticity are :

1. Availability of close substitutes

Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to other. For example, butter and margarine are easily substitutable.

By contrast, because eggs are a food without a close substitute, the demand for eggs is less elastic than the demand for butter.

2. Necessities versus Luxuries

Necessities tend to have inelastic demands, whereas luxuries have elastic demands.

Of course, whether a good is a necessity or a luxury depends not on the intrinsic properties of the good but on the preferences of the buyer. For avid sailors with little concern over their health, sailboats might be a necessity with inelastic demand and doctor visits a luxury with elastic demand.

3. Definition of the Market

The elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. For example, food, a broad category, has a fairly inelastic demand because there are no good substitutes for food. Ice cream, a narrower category, has a more elastic demand.

4. Time Horizon  :

Goods tend to have more elastic demand over longer time horizons. When the price of gasoline rises, the quantity of gasoline demanded falls only slightly in the first few months. Over time, however, people buy more fuel efficient cars, switch to public transportation, and move closer to where they work. Within several years, the quantity of gasoline demanded falls substantially.

Economists compute the price elasticity of demand as the percentage change in the quantity demanded divided by the percentage change in the price. That is,

Price            Percentage change in quantity demanded

elasticity  =    - - -  - - - - - - - - - -  -

of demand             Percentage change in price

e.g. suppose that a  15 percent increase in the price of an ice cream cone causes the amount of the ice cream to fall by 30%, the elasticity of demand is calculated as follows :

Price            30

elasticity  =    - - -   =  2

of demand        15

In this example the elasticity is 2, reflecting the change in the quantity demanded in proportionately twice as large as the change in price.

Other Related Posts :

Basic Principles of Economics.

Factors of Production

Determinants of Supply