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WHAT FACTORS MAY DETERMINE WHETHER A PRODUCT HAS ELASTIC OR INELASTIC DEMAND?

Updated on March 3, 2011

A number of factors influence the elasticity of demand for a product. In my last article, an explanation of elasticity of demand was provided. Demand is elastic when a certain percentage change in price of a product results a greater percentage change in quantity demanded. A product is said to have inelastic demand when a change in price results in a less than percentage change in quantity demanded. The purpose of this article is to examine possible factors that affect the elasticity of demand for a product. These factors include the following.

Availability of Substitute

The main determinant of elasticity of demand for a product is the availability of substitutes. Some commodities, such as margarine, cabbage and lamb have quite close substitutes, which are butter, other green vegetables and beef respectively. A change in the price of one of these commodities, the price of the substitute remaining unchanged, will lead consumers to substitute one commodity for the other. A fall in price leads consumers to buy more of a commodity and less of its substitute; and a rise in price leads consumers to buy less of the commodity and more of its substitute. More broadly defined commodities such as all foods, all clothing, cigarettes have few if any satisfactory substitutes. A rise in their price can be expected to cause a smaller fall in their quantities demanded than will be the case if substitutes were sufficiently available.

Commodities with close substitutes therefore, tend to have an elastic demand, whereas those with no close substitutes, an inelastic demand.

Related to substitution is time i.e. long-run and short-run. Indeed, it takes time to develop satisfactory substitutes. For this reason, a product that has inelastic demand in the short-run may prove elastic when enough time has elapsed. For example, before the first OPEC price shocks in the mid 1970s, the demand for petrol was thought to be highly inelastic because of the absence of satisfactory substitutes. However, the large price increases over the same period, led to the development of more fuel-efficient cars, which increased the elasticity of demand for petrol. If price had not fallen to its earlier level, then given some time span, petrol demand might have proved elastic. For now, due to the importance of petrol in the economic life a country, its demand is inelastic, at least until such a time that suitable substitutes may be developed, if that is possible.

The Proportion of the Consumer’s Income Spent on the Commodity

When only a small proportion of a person’s income is spent in buying a product, as for example salt, pepper, shoe polish, matches and others, no great efforts are made to look for substitutes when price of such a product rises. Demand for such goods is therefore relatively inelastic. On the other hand, where the expenditure on a commodity is fairly large, a rise in price of that product would compel the consumer to find substitutes thus making the demand elastic.

The Commodity’s own Price

Goods that are normally highly priced have elastic demand and commodities associated with low prices have inelastic demand. The reason is simple. At high prices, a large percentage of the consumer’s income may be involved in acquiring the commodity. The consumer therefore responds sensitively to price changes and the demand will be elastic. Owing to the fact that a small percentage of the consumers’ income goes into buying lowly priced goods, the demand is inelastic.

Consumer Income Level

The elasticity of demand for a product may also depend on the income level of the consumer i.e. whether the consumer is rich or poor. Rich men tend to have inelastic demand for most good s and services especially if they find the products very important to them. Their demand for goods and services is mostly inelastic. Poor men on the other hand, become very sensitive to price changes. Their demand for most commodities therefore, tends to be elastic.

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