As more close substitutes become available, demand tends to be more price elastic.

ILO:

> Explain what is meant by the concepts of price elasticity of demand

> Make simple calculations of price elasticity of demand

> Discuss the business relevance of different elasticity estimates

How might the demand for these goods be influenced if price was to increase? 

Factors that determine the value of price elasticity of demand

1. Number of close substitutes within the market -
The more (and closer) substitutes available in the market the more elastic demand will be in response to a change in price. In this case, the substitution effect will be quite strong.  

2. Luxuries and necessities -
Necessities tend to have a more inelastic demand curve, whereas luxury goods and services tend to be more elastic. For example, the demand for opera tickets is more elastic than the demand for urban rail travel. The demand for vacation air travel is more elastic than the demand for business air travel.  

3. Percentage of income spent on a good -
It may be the case that the smaller the proportion of income spent taken up with purchasing the good or service the more inelastic demand will be.  

4. Habit forming goods -
Goods such as cigarettes and drugs tend to be inelastic in demand. Preferences are such that habitual consumers of certain products become de-sensitised to price changes.  

5. Time period under consideration -
Demand tends to be more elastic in the long run rather than in the short run. For example, after the two world oil price shocks of the 1970s - the "response" to higher oil prices was modest in the immediate period after price increases, but as time passed, people found ways to consume less petroleum and other oil products. This included measures to get better mileage from their cars; higher spending on insulation in homes and car pooling for commuters. The demand for oil became more elastic in the long-run.

Business Relevance of PED 

Specification: DISCUSS the business relevance of P.E.D

l_as_level_economics_2881_january_2008_question_paper.pdf

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Now that you have a general idea of what elasticity is, let’s consider some of the factors that can help us predict whether demand for a product is likely to be elastic or inelastic. The following are important considerations:

• Substitutes: Price elasticity of demand is fundamentally about substitutes. If it’s easy to find a substitute product when the price of a product increases, the demand will be more elastic. If there are few or no alternatives, demand will be less elastic.
• Necessities vs. luxuries: A necessity is something you absolutely must have, almost regardless of the price. A luxury is something that would be nice to have, but it’s not absolutely necessary. Consider the elasticity of demand for cookies. A buyer may enjoy a cookie, but it doesn’t fulfill a critical need the way a snow shovel after a blizzard or a life-saving drug does. In general, the greater the necessity of the product, the less elastic, or more inelastic, the demand will be, because substitutes are limited. The more luxurious the product is, the more elastic demand will be.
• Share of the consumer’s budget: If a product takes up a large share of a consumer’s budget, even a small percentage increase in price may make it prohibitively expensive to many buyers. Take rental housing that’s located close to downtown. Such housing might cost half of one’s budget. A small percentage increase in rent could cause renters to relocate to cheaper housing in the suburbs, rather than reduce their spending on food, utilities, and other necessities. Therefore the larger the share of an item in one’s budget, the more price elastic demand is likely to be. By contrast, suppose the local grocery store increased the price of toothpicks by 50 percent. Since toothpicks represent such a small part of a consumer’s budget, even a significant increase in price is likely to have only a small effect on demand. Thus, the smaller the share of an item in one’s budget, the more price inelastic demand is likely to be.
• Short run versus long run: Price elasticity of demand is usually lower in the short run, before consumers have much time to react, than in the long run, when they have greater opportunity to find substitute goods. Thus, demand is more price elastic in the long run than in the short run.
• Competitive dynamics: Goods that can only be produced by one supplier generally have inelastic demand, while products that exist in a competitive marketplace have elastic demand. This is because a competitive marketplace offers more options for the buyer.

With these considerations in mind, take a moment to see if you can figure out which of the following products have elastic demand and which have inelastic demand. It may be helpful to remember that when the buyer is insensitive to price, demand is inelastic.

• Gasoline
• College textbooks
• Coffee
• Airline tickets
• Concert tickets
• Soft drinks
• Medical procedures

Self Check: Explaining Elasticity

Answer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not count toward your grade in the class, and you can retake it an unlimited number of times.

You’ll have more success on the Self Check if you’ve completed the two Readings in this section.

Use this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.

What happens to price elasticity when there are more substitutes?

Does more substitutes mean more elastic?

Are substitutes more elastic or inelastic?

How does the availability of close substitute affect the elasticity of supply?