Question

Identify and explain three of the factors that help determine how elastic demand for a particular good is. Discuss how the factors you select would help explain the price elasticity of demand for a sweater from Banana Republic.

Answer 1

Demand elasticity measures how sensitive demand for a good or service is to changes in other variables.

Factors affecting demand elasticity are :

Nature of goods : Goods have been classified into necessities or Luxurious goods. Luxurious goods have more elastic demand where as necessities good have inelastic demand.

Number of Close substitutes : The more close substitutes available in the market the more elastic is the demand because consumer can switch off easily and change there preferences like Coke and Pepsi.

Habit of using particular product. If a person is habitual in using a particular product than the good has inelastic demand.

Calculation of Elasticity of Demand

The midpoint method for calculating price elasticity of demand​ is the change in quantity divided by the average of the initial and final quantities divided by the change in price divided by the average of the initial and final prices.

Suppose initial price of product is $2.00, and the quantity is 100 units. Let us suppose that price rises to $3.00 and quantity becomes 80 units, respectively. That means, going from initial price to new price, the price increases by 50% (i.e. [3-2]/2) while quantity decreases by 20% (i.e. [80-100]/100). This indicates a price elasticity of 0.4 (i.e., 20/50)

These are the factors that affect price elasticity of demand for a Sweater from Banana Republic :

Number of Close substitutes - The price elasticity of demand is elastic as there are various brands available in the market . They have perfect substitutes availability in the market place. If they raise their price a person might switch to other brand of sweaters.

Habit of using Banana Republic good would shows that demand is inelastic. If price of the sweater has been increased the regular customer or brand conscious customer cannot switch to the other product.