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Determinants of The Price Elasticity of Demand The Availability of Close Substitutes

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25 views2 pages

Determinants of The Price Elasticity of Demand The Availability of Close Substitutes

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lawrencerenomeron
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Determinants of the Price Elasticity of Demand

1. The availability of close substitutes


-The demand is typically more elastic if a good can be easily substituted for another. This
means that people are likely to switch to buying a very similar good instead of continuing to buy
the good whose price increased. A close substitute would be a BIC ballpoint pen versus a
Papermate ballpoint pen. If both pens used to cost the same amount, but BIC decided to raise
their price by $0.15, then people would not find it difficult to simply switch over. This would
cause a large drop in demand for a relatively small increase in price.
2. Necessity versus luxury goods
-A consumer's elasticity of demand depends on how much they need or want the good.
Baby diapers are an example of a necessity and a good with inelastic demand. Diapers are
necessary for child rearing; parents must purchase more or less the same amount for their
children's health and comfort regardless of if the price rises or falls.
If the good is a luxury good, such as a Burberry or Canada Goose jacket, then people
might choose to go with a more cost-effective brand such as Colombia if the luxury brands
decide to price their jackets at $1,000, while Colombia uses similar quality materials but only
charges $150. People will be more elastic to price fluctuations of luxury goods.
3. The definition of the market
-The definition of the market refers to how broad or narrow the range of goods available
is. Is it narrow, meaning the only goods in the market are trench coats? Or is the market broad
so that it encompasses all jackets or even all forms of clothing?
If a market is defined as "clothing" then the consumer really has no substitutes to
choose from. If the price of clothing goes up, people will still buy clothing, just different kinds or
cheaper kinds, but they will still buy clothing, so the demand for clothing won't change much.
Thus, the demand for clothing will be more price inelastic.
4. The time horizon
-The time horizon refers to the time in which the consumer must make their purchase.
As time goes by, demand tends to become more elastic as consumers have time to react and
make adjustments in their lives to account for price changes. For example, if someone relied on
public transport for daily commuting, they will be inelastic about a change in the ticket fare over
a short period. But, if the fare increases, commuters make other arrangements in the future.
They may choose to drive instead, carpool with a friend, or ride their bike if those are options.
They simply needed time to react to the change in price. In the short run, consumer demand is
more inelastic but, if given time, it becomes more elastic.
Determinants of the Price Elasticity of Supply

1. Availability of Key Resources


-The accessibility of resources like labor, raw materials, and technology greatly
influences supply's elasticity. More availability can enable faster adjustments to the quantity
supplied following price changes.
2. Duration of the Production Cycle
-The time required for the production process also impacts supply's elasticity. Short-term
changes can be challenging due to time constraints or seasonal factors, making supply more
inelastic.
3. Technological Limitations
-Constraints in technology can restrict the suppliers' ability to react promptly to price
changes, therefore making supply inelastic.
4. Cost of Production and Time to Adjust Production
-As the cost of production rises, more resources are needed, reducing efficiency and
leading to lower price elasticity of supply. However, efficient production processes can lead to
high supply elasticity as seen in the fast fashion industry.

What are the income and cross elasticities of demand? Why might they be useful? Explain.
- Income and cross elasticity measure how responsive one variable is to change the other. It is
used in economics to study the relationship between wages and productivity. In simple terms, cross
elasticity measures how much change in one variable (wages) is associated with a change in another
(productivity).
This is useful because businesses use income elasticity of demand to predict and plan
for potential changes in pricing, budgeting and production. The formula for calculating income
elasticity of demand is % of the change in quantity purchased (from one time period to another,
typically year over year) divided by % of the change in income.

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