The Factors that Influence the Elasticity of Demand
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The elasticity of demand among products varies substantially. The determinants of price and income elasticity of demand are:
- The closeness of substitutes. The most important determinant is the availability of substitutes. The closer the substitutes for a good or service, the more elastic the demand for it.
- Necessities, such as food or housing, generally have inelastic demand.
- Luxuries, such as exotic vacations, generally have elastic demand.
When good substitutes for a product are available, a price rise induces many consumers to switch to other products. For example, when the price of apples rises, many consumers simply switch to oranges or other fruits. However, when the price of gasoline rises, most consumers can only slightly cut back their consumption of gasoline, since there is no good substitute for gasoline.
- The proportion of income spent on the good. If expenditures on a product are quite small relative to a consumer's budget, the income effect will be small even if there is a substantial increase in the price of the product. This will make the demand less elastic. For example, if the price of matches triples, consumers would not bother to find substitutes, since they only spend a few bucks on matches each year.
- The time elapsed since a price change. The more time consumers have to adjust to a price change, or the longer a good can be stored without losing its value, the more elastic the demand for that good. In general, when the price of a product increases, consumers will reduce their consumption by a larger amount in the long run than in the short-run. Therefore, the demand for most products will be more elastic in the long run than in the short run.
The price elasticity of demand tends to increase in the long run.
As changing market conditions raise or lower the price of a product, both consumers and producers will respond. However, their response will not be instantaneous, and it is likely to become larger over time. In general, when the price of a product increases, consumers will reduce their consumption by a larger amount in the long run than in the short run. Thus, the demand for most products will be more elastic in the long run than in the short run. This relationship between the elasticity coefficient and the length of the adjustment period is referred to as the second law of demand