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<sharethis /> Elasticity of Demand Prices are always subject to change based upon market forces and the interaction between the consumer and the producers in the business. This change in prices is known as elasticity. Two types of elasticity are existed: The demand elasticity and the supply elasticity. In the following we will focus and emphasize the demand elasticity. Demand Elasticity - Demand is elastic when a small change in price causes a large change in demand. Demand is inelastic when a change in price does not cause a large change in demand, or any change at all. How can we tell which products are elastic and which are inelastic. Let us answer the following. Can we wait with the purchase or do we need to buy it right a way? When there is a reduction in price more people tend to buy the product, whereas, increasing in price of this product cause less consumption. Reduction in price usually happens after the product has been in the market for a while, more people demand it, since they can afford it now (because of lower price). Therefore, if people want to buy a new stereo they should wait until the price drops. In this case, demand will vary greatly in accordance with price, thus product tend to be elastic. On the other hand, if people need to fill their cars with gasoline, they won’t be able to wait; the demand is going to remain the same, even if the price is higher for gasoline. Thus demand doesn’t vary greatly with price and the product tends to be inelastic. Are there any substitutes available? If a product has many substitutes, the demand for it tends to be elastic. If there is less substitutes available for a product, the demand will be inelastic. If products have more substitutes available more people will demand the substitution, because it’s less pricy, For example, if the price of coffee were to go up, then many people would switch to tea (because it’s less pricy), thus a substitute is available. Price is causing demand to drop. The coffee would then be considered elastic because it has substitution (tea). Since there is no real substitute for gasoline, demand remains the same regardless of price. These products are inelastic.
Does the purchase use a large portion of income? If a product is expensive, and is a large percentage of one's income, then the product tends to be more elastic. If a product is not a significant portion of the income the product tends to be more inelastic. For example, if the price of houses (or expensive product that is large percentage of one’s income) were to drop, demand would vary greatly (increasing in demand), which means that the product is elastic (large responsiveness between the demand and the price corresponding). The opposite will happen with cheaper products. Price Elasticity of Demand the Formula:
Ed= percent change in quantity demanded
Percent change in price
Elasticity: % change in quantity Change in Q / Q
--------------------------- = --------------------- % change in price Change P / P
When E>1 = Elastic When E<1 = Inelastic When E=1 unit Elastic Figure 3.a.1 Elastic Demand