Question

The price elasticity of demand for product A is 2.32. The price elasticity of demand for product Z is 0.12. This difference could be due to the fact that

A. there are many good substitutes for product A and few substitutes for product Z.

B. there are many good substitutes for product Z and few substitutes for product A.

C. product A is a necessity and product Z is a luxury.

D. product Z is a necessity and product A is a luxury.

E. Both A and D are correct.

Answer 1

Both A and D are correct

When demand doesn't change more than the change in price then the demand is known to be inelastic and when demand change more than the change in price then demand is known to be more elastic.

When elasticity of demand is more than 1 then the demand is known to be more elastic and when elasticity of demand is less than 1 then the demand is known to be inelastic.

Therefore product A has elastic demand as price elasticity is 2.32 which is greater than 1 and product Z has inelastic demand as price elasticity is 0.12 which is less than 1.

Two important factor affecting price elasticity of demand for a good is nature of commodity and availability of substitutes.

Nature of commodity - Ordinarily necessaries like salt, oil, vegetables etc have inelastic demand. Luxuries like air conditioner, costly furniture etc have more elastic demand.

Availability of substitutes - Demand for goods which have close substitutes (like tea and coffee being close substitute of each other) is relatively more elastic. Because, when price of such a good rises, the consumer has option of shifting to its substitute. Good without close substitutes like cigarettes and liquor have inelastic demand.

Product A has elastic demand which means product A has is luxury good as well as has many substitutes whereas product Z has inelastic demand which means product Z is a necessary good and has less substitutes.