Price elasticity of demand and the factors that affect it

Meaning of price elasticity of demand. The law of demand tells us only the direction in which quantity demanded moves when the price of a good changes. Price elasticity of demand tells us by how much: it measures how responsive the quantity demanded of a good is to a change in its own price. For some goods buyers cut back sharply when the price rises; for others they hardly change what they buy. Elasticity is a measure of this willingness of buyers to adjust.

How it is measured. It is the ratio of two percentage changes:

eD = (% change in quantity demanded) ÷ (% change in price) = (ΔQ / Q) ÷ (ΔP / P) = (ΔQ / ΔP) × (P / Q),

where ΔQ and ΔP are the changes in quantity and price and Q and P their starting values.

• Sign. Price and quantity demanded move in opposite directions, so eD is negative; by convention its absolute value is used.
• Base. Because a percentage depends on the base, the same pair of points can give different answers depending on which end is taken as the start; the mid-point method, which uses the average price and the average quantity as the base, removes this difference.

Degrees of price elasticity.

Elasticity along a demand curve. Elasticity is not the same as slope. On a straight-line demand curve the slope is constant, yet the elasticity falls as we move down the curve: it is greater than 1 above the mid-point, equal to 1 at the mid-point and less than 1 below it, reaching 0 where the curve meets the quantity axis. The schedule in the question is not a straight line, so its elasticity does not fall at every step, but it is high at the top and low at the bottom. Between A and B, a price cut of one-seventh (₹7 to ₹6) doubles the quantity (120 to 240), so demand is very elastic (7, with the starting values as base); between F and G, halving the price (₹2 to ₹1) raises quantity by only one-fifteenth (900 to 960), so demand is very inelastic (about 0.13). In between it moves unevenly: on the same base it is 1.5 from B to C but 5 from C to D, before falling to 1.2 from D to E and about 0.46 from E to F. Part (b) measures it between C and F.

Factors that affect the price elasticity of demand. The examples are our own.

1. Time allowed for adjustment. Buyers can respond more fully the longer they have. When a city's metro fares rise, most commuters keep riding at first; over a year or two some buy scooters or move closer to work. Demand is more inelastic in the short run and more elastic in the long run.
2. Whether the good is a necessity or a luxury. Goods people cannot do without, such as rice, salt or a daily medicine, are bought in almost the same amount after a price rise, so their demand is inelastic; goods that can be cut back, such as air-conditioners or holidays abroad, have elastic demand.
3. Share of the budget. A good that takes a tiny part of income, such as a ₹2 sachet of shampoo, is bought much as before even if its price doubles, because the extra cost is hardly noticed; a good that takes a large share, such as a motorcycle, has more elastic demand.
4. Availability of close substitutes. When close substitutes are easy to find, buyers switch if the price rises, so demand is elastic; when there are none, demand is inelastic. One brand of packaged atta has many rivals on the shelf; household piped water has hardly any.
5. Whether purchase can be put off. If buying can wait, as with replacing a working smartphone, buyers delay when the price rises and demand is elastic; if it cannot wait, demand is inelastic.
6. Number of uses. A good with many uses is cut back to its most important uses when its price rises, so its demand responds more. Milk goes into tea, curd and sweets, and a household facing dearer milk can give up the sweets first.
7. How narrowly the good is defined. Demand for food as a whole is inelastic, but demand for one variety of a food is more elastic, because buyers can move to another variety. Demand for vegetables changes little with price; demand for cauliflower in particular changes much more.

Conclusion. Price elasticity of demand measures the percentage response of quantity demanded to a percentage change in the good's own price; it ranges from zero (perfectly inelastic) to infinity (perfectly elastic) and usually varies along a demand curve. It is higher where substitutes are close, the good is a luxury or a large item in the budget, purchase can be postponed, the good has many uses or is narrowly defined, and buyers have more time to adjust.