Price elasticity of demand is a measurement of the change in the
consumption of a product in relation to a change in its price, in other words, how sensitive the quantity
demanded is to its price.
Economists
use price elasticity to understand how supply and demand for a
product change when its price changes.
Depending on its elasticity,
a good is said to have elastic demand, inelastic demand, or unitary elastic
demand.
If demand is elastic, the
quantity demanded is very sensitive to price.
If demand is inelastic, the
good's demand is relatively insensitive to price, with quantity changing less
than price.
If demand is unitary
elastic, the quantity falls by exactly the percentage that the price rises.
Two important special cases
are perfectly elastic demand, where even a small rise in price reduces the
quantity demanded to zero; and perfectly inelastic demand, where a rise in
price leaves the quantity unchanged.
Factors That Affect Price Elasticity of Demand
Availability of substitute goods: The more and closer the substitutes available, the more elastic is that good likely to be, as people can easily switch from one good to another if an even minor price change is made. If no close substitutes are available, the demand inelastic.
Breadth of definition of a good: The broader the definition of a good or service, the lower the elasticity.
Percentage of
income: The higher the percentage of
the consumer's income that the product's price represents, the higher the
elasticity (more elastic) tends to be, as people will pay more attention when
purchasing the good because of its cost.
When the goods represent only a negligible portion of the budget the income effect will be insignificant and demand inelastic,
Necessity: The more necessary a good is, the lower the elasticity (more inelastic), as people will attempt to buy it no matter the price.
Duration: For most goods, the longer a price change holds, the higher the elasticity is likely to be, as more and more consumers find they have the time and inclination to search for substitutes.
Brand loyalty: An attachment to a certain brand can
override sensitivity to price changes, resulting in more inelastic demand.
Addictiveness: Goods that are more addictive in nature tend to be more inelastic. This is because consumers treat such goods as necessities and hence are forced to purchase them, despite even significant price changes.
Based on all of
the above, it is important that the demand forecaster is familiar with pricing
actions taken by the company and anticipate their impact on demand.
