Explain 5 factors that influence price elasticity of demand.
Price elasticity of demand measures the change in quantity demand when the price of a commodity changes. For a commodity with elastic demand, the increase in price will decrease the demand for a good. The main factors that influence the price elasticity of demand are:
- availability of substitutes: a commodity with a large number of potential substitutes will have high elasticity, since a small change in price will encourage the consumers to use a substitute. On the other hand, a lack of substitutes will make a commodity's demand inelastic.
- Proportion of income spent on the commodity: If a high proportion of income is spent on a particular commodity, its demand will be elastic. In comparison, for items requiring a small proportion of income such as soap, tea, milk, oil, etc., the demand is inelastic. Even if the prices of these items were to be increased, consumers will still buy the same quantity, since the effect on overall budget would be small.
- Uses of the commodity: A commodity with multiple potential uses will have high elasticity of demand. An increase in price for such a commodity will cause a fall in demand and it will be used only for most urgent applications. However, a fall in price will increase the demand and it will be used for other, less important applications.
- Complementarity between goods: goods that are complementary to each other will have less elasticity as compared to goods that are used alone. For example, salt is used in cooking with vegetables and meat. Even if its price were to rise, the change in budget would be small, since only a small amount of salt is used (in comparison to meat or vegetable) and hence its demand will be relatively inelastic.
- Time and Elasticity: In a relatively longer time frame, it is easier for consumers and businesses to adopt substitutes and hence, over a longer time interval, the demand is more elastic.