4 Most Important Determinants of Price Elasticity of Demand

However, mere availability of substitutes is not enough to ensure high price elasticity of demand. Steady supply of substitutes in the market is also important in determining price elasticity. In some cases, the substitutes are not readily available. So high lead- time (time a gap between ordering a product and receiving it) of substitutes reduces the value of price elasticity.

Beside the number and availability of substitutes, the closeness of the available substitutes is also very important. For example, butter has two substitutes – cheese and margarine. Of these two, as a substitute, margarine is closer to butter than is cheese. Hence, if we consider cheese as the only substitute for butter, the elasticity will be lower than the case of considering margarine as its substitute.

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2. Budget Share:

Demand is relatively inelastic for products where a negligible proportion of income is spent. For the items like salt, rubber bands, etc. small shares of total budget of the consumers are required and people generally do not bother to change the amount of consumption even if the price of these items change.

This is because the consumption of these products per head per month is usually very small and even after a price hike (of course up to a certain limit), the customers do not reduce its consumption as it hardly changes their purchasing capacity.

Price elasticity of demand for a normal product is summarized in a tabular form below:

A relationship is defined asWhen the value of elasticity isWhich implies that
Perfectly elasticInfinityVery small increase (decrease) in price causes an infinitely large decrease (increase) in the quantity demanded
ElasticLess than infinity but greater than oneThe percentage decrease (increase)in the quantity demanded is greater than the percentage increase (decrease) in price
Unit elasticOneThe percentage decrease (increase) in the quantity demanded is equal to the percentage increase (decrease) in price
InelasticGreater than zero but less than oneThe percentage decrease (increase)in the quantity demanded is less than the percentage increase (decrease) in price
Perfectly inelasticZeroThe quantity demanded remains the same at all prices

3. Nature of Products:

Price elasticity of demand also depends on the nature of the product in consideration. For luxury items (e.g., jewellery), price elasticity is comparatively higher than it is for necessity items, because even if the price changes, the consumer will not be able to reduce the level of consumption of necessity goods, i.e., the value of ?Q is negligible or zero, whereas the consumption of luxury items can be curtailed if the price of it increases. It is assumed here that income of the consumers and other factors remain the same.

4. Time:

The quantum of time lapse since the price change is another considerable factor. Even if the price of a product changes (specially in case of increase in price), customers may not change their consumption level instantaneously.

This may be due to the habit of consumers and also, due to non-­availability of substitutes. But with the passage of time, as new and cheaper substitutes become available in the market, consumers may change their purchasing behaviour and start buying the cheaper varieties.