Elasticity of demand is the sensitivity of demand for a good or service due to a change in another factor. Economists measure the elasticity of demand to determine how consumer behavior and spending patterns are affected when specific factors are taken into account.
A good that has a high elasticity of demand for an economic variable means that consumer demand for that good is more sensitive to changes in the variable. Conversely, a good with low elasticity of demand means that regardless of changes in an economic variable, consumers do not adjust their spending habits.
Factors that influence the elasticity of demand
Below are the factors that have the greatest influence on the elasticity of demand for a product or service.
Kind of good
There are three types of goods: necessities, comfort and luxury. Basic necessities are basic necessities such as food and shelter. Comfort items are items that make life more enjoyable and happier, such as televisions, organic food, or a gym membership. Luxury goods provide added pleasure and may include a sports car, boat, or expensive watch.
Goods that are a necessity are generally inelastic, which means that a change in price is unlikely to impact demand. If the price of gasoline goes up, for example, demand doesn’t change much since people have to use their cars to get to work. Comfort and luxury products tend to be more elastic, as changes in an economic variable can lead to lower consumer demand.
It is important to take into account the taste and point of view of a consumer because one may regard a product as a convenience while another may consider it a luxury. For example, most people own a car and need it to get to work every day. However, some people who can barely afford food or shelter may consider a car a luxury.
One factor that can affect the elasticity of demand for a good or service is its price level. For example, a change in the price level of a luxury car can lead to a substantial change in the quantity demanded. If, for example, a luxury car maker has excess inventory of cars, the company may lower prices to increase demand. If the price is reduced enough, the car could be affordable for consumers who could not afford the original price of the luxury car.
Of course, the magnitude of the price change can determine whether or not the demand for the good changes and if so, by how much.
Also known as the income effect, the income level of a population also influences the elasticity of demand for goods and services. For example, suppose an economy is facing an economic downturn where many workers have been made redundant. The decline in the annual incomes of the majority of the population could make luxury items more elastic. In other words, a recession could cause people to save their money rather than splurging on luxury items like flat screen TVs or expensive watches.
Availability of substitutes
If there is a readily available substitute for a good, the substitute makes the demand for the good elastic. In other words, the alternative product makes the demand for a good or service sensitive to price changes. For example, let’s say the price of Florida oranges has gone up due to bad weather or a bad harvest. If California oranges are a close substitute in terms of quality and price, consumer demand will increase.