The following ten points highlight the factors that affect price elasticity in economics.
The ten factors are: 1. The Availability of Substitutes 2. Definition of the Commodity 3. Durability, 4. Income level 5. The Proportion of Expenditure Spent on the Commodity 6. Time 7. The Number of Uses 8. Necessities and Luxuries 9. Addiction 10. The Level of Price.
1. The Availability of Substitutes:
Commodities which have good substitutes have an elastic demand. Tea can be substituted by coffee. If the price of tea rises many people can give it up and use coffee. Hence, a rise in the price of tea will lead to a large fall in the quantity purchased of coffee. Commodities which have no good substitutes have an inelastic demand because people cannot turn to any other commodity when price rises.
2. Definition of the Commodity:
Price elasticity of demand depends on how closely a commodity is defined. In fact, the availability of substitutes depends on the definition of the commodity. Suppose we consider food. Food is a broad item of human consumption. It has no substitute. Therefore, the demand for food is inelastic. On the other hand, we can adopt a narrow definition of food and consider a particular variety of food such as fish. If the price of fish rises very much, most people will buy more eggs or mutton.
Thus, the demand for fish is elastic. Similarly, the demand for a particular variety of cigarettes is more elastic than the demand for cigarettes in general. If the price of cigarettes rises its demand may not fall much (because most people smoke cigarettes due to addiction). But if the price of a particular variety of cigarettes rises faster than prices of other varieties, the demand for the former variety will fall very much.
If a commodity is not durable, e.g., toilet paper, it will have to be replaced fairly often, even though the price has risen in the meantime. Thus a rise in price does not have a great effect on quantity demanded—demand is inelastic.
Commodities which last a long time, i.e., durable commodities (e.g., radios, TV. sets, etc.), have an inelastic demand. The reason is that when the prices of such commodities increase people can postpone purchases. Hence, the quantity demanded is not much affected by price changes.
4. Income Level:
People with high incomes are less affected by price changes than people with low incomes. A rich man will not curtail his consumption of sugar even if its price rises considerably. He will continue to purchase the same quantity as before. But a poor man cannot do so. Hence, the demand for sugar is inelastic for the rich, elastic for the poor.
5. The Proportion of Expenditure Spent on the Commodity:
If a large proportion of people’s expenditure is taken up by a commodity, a change in price is likely to have a greater effect on quantity demanded than if the proportion had been very small. For example, if an individual goes to a movie at a particular venue three times each week and the price of admission is doubled, then he may cut down on the number of times he goes there. If, on the other hand, an individual goes there only once or twice a year, the doubling of the price is not likely to have as great an effect.
Again, if we think of a low-priced commodity such as ink, a doubling of the price will not have as much effect on quantity demanded as would, for example, a doubling of the price of meat or chicken.
Thus, if a commodity takes up a large proportion of expenditure, demand is likely to be more elastic than it will be for a commodity which takes up only a small proportion of expenditure.
Time also exerts considerable influence on price elasticity of demand. Demand is more elastic in the short run than in the long run. If, for instance, taxi fare in Kolkata rises by 25% all of a sudden, the demand for the services of taxi will fall drastically for at least one or two weeks. But demand will gradually pick up thereafter and demand will be less elastic (more inelastic) after some time.
The basic reason is that people’s initial reaction to price increase is more drastic than people’s ultimate reaction to it. Price elasticity of demand is likely to be greater, the longer the time period involved. For one thing, it takes time for people to become aware of price changes. As time goes on, more and more people will become aware of a change in the price of a commodity and will adjust their demand accordingly, if they so wish.
Another reason why elasticity will be righter in the long run is that when the price of a commodity rises, some people who are particularly fond of the commodity will put off reducing their purchases for as long as they can.
7. The Number of Uses:
Commodities which can be used for a variety of purposes have an elastic demand. Coal is used in factories, railways and also for cooking. When its price falls, it will be demanded more for all these purposes and the total increase in demand will be large.
Conversely, when its price rises, its use can be much reduced for some purposes, for example, people will use wood in its place for cooking. Hence, the demand for such a commodity is elastic. Again, when a commodity is used only for one or two purposes, its use in those purposes cannot be altered much. Hence, price changes have less effect.
8. Necessities and Luxuries:
Salt, for instance, is a necessary article. A certain amount of salt must be consumed, whatever be the price. Even if its price rises it is impossible to reduce its consumption much. On the other hand, if the price of salt falls, people generally do not eat more salt. Hence, changes in the price of this commodity do not have much effect on its consumption. But salt is used in some industrial processes like tanning of leather.
Therefore, a fall in the price of salt will lead to some increase in the amount purchased. But as the major part of the salt produced is used for eating, the total amount purchased will not increase much. Hence, the demand is inelastic. Luxury articles have an elastic demand. The consumption of luxuries can be quickly reduced when price rises. Also, when the price of such articles falls people quickly increase consumption because such articles give pleasure.
There are certain commodities which people have become too much accustomed to use, for example, betel-nut and tobacco. The consumption of such commodities is not much reduced even when the price rises.
10. The Level of Price:
When prices are already high further rise quickly curtails consumption. When prices are low small changes have less effect. Therefore, demand is elastic at the upper levels of prices, inelastic at the lower levels.
From the rules stated above, we can deduce the nature of the elasticity of the following goods:
Necessaries for existence and for efficiency have an inelastic demand, e.g., rice, wheat, salt, low priced vegetables, cheap oil etc. Textbooks usually have an inelastic demand.
Conventional necessaries have inelastic demand, e.g., cigarette, tobacco, etc.
Luxuries have elastic demand because they are purchased only by those who have high incomes e.g., gold necklace, transistor, TV. set, motor car, etc.
The want for durable goods can be postponed. Therefore their demand is elastic. Some essential furniture have an inelastic demand but mostly all expensive furniture have elastic demand.
The income level:
Rich people are not much affected by price changes. Therefore the nature of elasticity of demand depends on the income level of the person concerned. The demand for sugar is inelastic for the rich but elastic for the poor. The same applies to fine cloth and fish.
Factors of production:
The demand for a factor of production varies directly with the demand of the goods for which they are produced, e.g., cement, structural rods etc. Usually these goods have an elastic demand.
Statistics on price elasticity:
The price elasticity of most food—articles is low.
The price elasticity of manufactured goods tends to be fairly elastic.