Elasticity of demand measures the sensitivity of demand for a good or service to changes in other variables. In fact, many factors are important in determining the elasticity of demand for a good or service, such as price level, type of good or service, availability of a substitute, and income levels of consumers. consumers.
Key points to remember
- Many factors determine the elasticity of demand for a product, including price levels, type of product or service, income levels, and the availability of any potential substitutes.
- High priced products are often very elastic because, if prices fall, consumers are more likely to buy at a lower price.
- Compared to basic necessities, luxury items are very elastic.
- Goods with many alternatives or competitors are elastic because, as the price of the good increases, consumers shift their purchases to substitute items.
- Income and elasticity are linked: as consumers’ incomes increase, so does the demand for products.
The price level of an item affects the demand for a good or service, and the price elasticity of demand can be used to measure the sensitivity of a change in the quantity demanded of a good or service. of a service versus a price change. The price elasticity of demand is calculated by dividing the percentage change in the quantity demanded of a good or service by the percentage change in its price level.
For example, luxury goods have a high price elasticity of demand because they are sensitive to price changes. Suppose the prices of LED TVs go down by 50%. The demand is increasing because they are more affordable for those who could not buy them before.
The type of good or service also affects the elasticity of demand. A good or service can be a luxury item, a necessity or a convenience for a consumer. When a good or service is a luxury or comfort good, demand is highly elastic with respect to the price of a necessary good. Conversely, the demand for an essential good, such as food, is generally price inelastic because consumers still buy food even if the price changes.
Income and alternatives
The availability of alternatives or substitutes can affect the elasticity of demand. Therefore, the demand for goods or services with many substitutes is highly price elastic; a small increase in the price levels of goods leads consumers to buy its substitutes. For example, the demand for soda is very price elastic due to a large number of substitutes. If the price of a soda goes up, consumers can choose to buy the cheaper substitute.
When close substitutes are available, the quantity demanded is very sensitive to changes in the price level and vice versa. The elasticity of demand for goods with close substitutes is measured by dividing the percentage change in the quantity demanded of a product by the percentage change in the price of a substitute product. This formula is also known as cross elasticity of demand.
Finally, the level of consumer income plays a role in the elasticity of demand for goods and services. Income elasticity of demand is used to measure the sensitivity of a change in the quantity demanded to a change in consumer income. Different types of property are affected by income levels. For example, lower quality products, such as generics, have negative income elasticity of demand because the quantity demanded for generic products tends to decrease as consumers’ incomes increase.