Explain the concept of price elasticity of demand. Choose two goods and explain why they might have different price elasticity of demand.

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Price elasticity of demand is a very important concept for people who run businesses.  It has to do with how much the quantity demanded of a product will change when its price changes.  Therefore, it helps a person set prices in such a way as to maximize their revenues.


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law of demand tells us that, ceteris paribus, people are willing and able to buy more of a good as its price declines and less of a good when its price increases.  However, the law does not tell us that rate of change in quantity demanded.  It does not tell us how much the quantity demanded will drop when the price increases or increase when the price drops.  Price elasticity of demand is useful because it gives us this information.

There are many reasons why different products might have different levels of elasticity.  Perhaps the most important is whether there are substitutes for that product.  Think about the difference between gasoline and oranges.  There are very few substitutes for gasoline, particularly in a short period of time.  If the price of gas goes up, you cannot switch to running your car on something else.  You might drive less, but you cannot really replace gas.  By contrast, there are lots of substitutes for oranges.  If their price goes up, you might buy apples, grapes, kiwi, strawberries, or any number of other fruits instead.  There is no need to keep buying oranges as their price rises.  For these reasons, the demand for oranges will be much more elastic than the demand for gasoline.

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