Question

Describe the 4 determinants of price elasticity of demand. Use each determinant to describe how a demand for a product might be elastic or inelastic.

Answer 1

The following are the main factors which determine the price elasticity of demand for a commodity: 1. The Availability of Substitutes 2. The Proportion of Consumer’s Income Spent 3. The Number of Uses of a Commodity 4. Complementarity between Goods 5. Time and Elasticity.

Determinant # 1. The Availability of Substitutes:

Of all the factors determining price elasticity of demand the availability of the number and kinds of substitutes for a commodity is the most important factor. If for a commodity close substitutes are available, its demand tends to be elastic. If the price of such a commodity goes up, the people will shift to its close substitutes and as a result the demand for that commodity will greatly decline.

Determinant # 2. The Proportion of Consumer’s Income Spent:

Another important determinant of the elasticity of demand is how much it accounts for in consumer’s budget. In other words, the proportion of consumer’s income spent on a particular commodity also influences the elasticity of demand for it. The greater the proportion of income spent on a commodity, the greater will be generally its elasticity of demand, and vice versa.

Determinant # 3. The Number of Uses of a Commodity:

The greater the number of uses to which a commodity can be put, the greater will be its price elasticity of demand. If the price of a commodity having several uses is very high, its demand will be small and it will be put to the most important uses and if the price of such a commodity falls it will be put to less important uses also and consequently its quantity demanded will rise significantly.

To illus­trate, milk has several uses. If its price rises to a very high level, it will be used only for essential purposes such as feeding the children and sick persons. If the price of milk falls, it would be devoted to other uses such as preparation of curd, cream, ghee and sweets. Therefore, the demand for milk tends to be elastic.

Determinant # 4. Complementarity between Goods:

Complementarity between goods or joint demand for goods also affects the price elasticity of demand. Households are generally less sensitive to the changes in price of goods that are complementary with each other or which are jointly used as compared to those goods which have independent demand or used alone. For exam­ple, for the running of automobiles, besides petrol, lubricating oil is also used.

Now, if the price of lubricating oil goes up, it will mean a very small increase in the total cost of running the automobile, since the use of oil is much less as compared to other things such as petrol. Thus, the demand for lubricating oil tends to be inelastic.

Determinant # 5. Time and Elasticity:

The element of time also influences the elasticity of demand for a commodity. Demand tends to be more elastic if the time involved is long. This is because consumers can substitute goods in the long run. In the short run, substitution of one commodity by another is not so easy. The longer the period of time, the greater is the ease with which both consumers and businessmen can substitute one commodity for another.