Price Elasticity of Demand

Price elasticity of demand : The responsiveness of quantity demanded to a change in price. PeD = % change in Q / % change in P.

More than 1 = elastic

1 = unity

less than 1 = inelastic

Determinants of price elasticity of demand:

Substitutes: When the price of a good rises, people will switch to cheaper substitutes. The price elasticity of demand becomes greater.

The proportion of income spent on the good: The higher the proportion of income we spend on a good, the more we will be forced to cut consumption when the price rises, the bigger will be the income effect and the more elastic will be the demand and vice versa (e.g. table salt, box of matches).

The time period: When prices rise, people may take time to adjust their consumption pattern and find alternatives. The longer the period after a price change, then the more elastic the demand is likely to be. Between December 1973 and June 1974 the price of crude oil quadrupled which led to similar increases in the price of petrol and central heating oil. Over the next few months, there was only a very small reduction in the consumption of oil products. Demand was highly inelastic. The reason for this was that people still wanted to drive their cars and heat their houses. Over time, however (with smaller cars, economical carburettors, other forms of central heating) people switched to gas, insulation systems, etc.

Price elasticity of demand and consumer expenditure:

Elastic demand: As the price rises so the quantity demanded falls, and vice versa. When demand is elastic the quantity demanded changes proportionately more than price. Thus the change in quantity has a bigger effect on total consumer expenditure than does the change in price.

Inelastic demand: When demand is inelastic, it is the other way round.