Why are goods Demand Elastic?

This is probably the element which determines more than anything else whether the good is demand elastic or demand inelastic.

The easier it is to purchase a product which satisfies more or less the same requirement within the same general price range, the higher will be the elasticity of the original product.

Let us take as an example cans of orange. If the price of a particular brand of orange increases by, say, 10% while the price of all other cans remains constant, it is likely that the demand for the can which has increased in price will fall off by more than 10%.

Why? When the other cans are readily available, and are within the same general price range, they will be seen as presenting better value, and more of them will tend to be bought.

The greater the availability, and the greater the closeness, of substitute goods, the higher will be the elasticity of demand.

If one brand of petrol increases in price, all other things being equal, the rational motorist will switch to a brand which has not increased in price. We may say that petrol has a very high level of inelasticity of demand - more or less the same quantity will be demanded, regardless of price changes (within realistic boundaries). However, the PRICE ELASTICITY OF DEMAND of any particular brand of petrol can be said to be very high, all other things being equal.

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Complementary goods are goods which are used in conjunction with each other. They are also known as goods which are in "joint demand".

The general rule is

The cheaper of two goods which are complementary goods will tend to be inelastic relative to the other complementary good.

In the short-term, you would expect the demand for petrol to be affected more by changes in the price of cars than by changes in the price of petrol. Likewise, the demand for Internet connections will be affected less by a change in the price of Internet connection than by the price of computers.

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The Percentage of income which is spent on the good

All other things being equal, it is highly unlikely that a price increase of 25% on a box of matches, bringing the price from say 10p to 12.5p, will cause any significant decrease in the demand for matches. This is because the proportion of income spent on matches is so small that factors other than its own price will determine the PRICE ELASTICITY OF DEMAND of matches.

Whether the good is a luxury or a necessity

If a good is considered to be a luxury, something without which we can survive quite well - something we want, rather than need - the demand for it will tend to be relatively elastic. If the price of the luxury goes up by 10%, the demand for it, all other things being equal, will decrease by more than 10%.

If a good is considered to be a necessity - something without which we cannot survive - something we need, rather than want - the demand for it will tend to be relatively inelastic. If the price of the necessity goes up by 10%, the demand for it, all other things being equal, will not decrease by 10%.

A necessity is something which is considered vital for survival - food, clothing, shelter, security, etc.

What some of us would consider to be a luxury, others would deem a necessity. There are people who honestly believe that they could not survive without a television in every room.

How durable is the good?

The longer a good is expected to last, the more durable it is, the greater the Price Elasticity of Demand for it is going to be.

If the price of televisions, for example, increases it is likely that the consumer will try to extend the use of the present television set and postpone replacing it until his or her income rises and the television set costs the same percentage of income as it did before the price increase.

The more durable the good, the higher the elasticity of demand it has.

Expectations as to future price changes

Every year, prior to the presentation of the Annual Budget by the Minister for Finance, speculation rules supreme.

Will the "old reliables" suffer an increase in taxation again this year?
Will excise duties on cigarettes, petrol, spirits, etc. be increased?
Will the VAT standard rate change?

A 1% increase in price may cause a greater than 1% increase in demand (effectively making the goods Giffen goods); people may buy more now because they believe that the goods may be even dearer in the weeks to come.

The reverse also holds true. If goods actually decrease in price, the population may believe that there are even further reductions coming, and therefore the demand may be relatively inelastic. A 1% fall in price may not lead to a 1% increase in demand because it may be rumoured that even further price reductions are on the way.

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Size of Income:

The wealthier one is the more shielded one may be from the effects of price increases.

Product Loyalty:

If one has been purchasing a certain brand of a good over a period of time, one may be inclined to continue the habit of buying that good in preference to a substitute good which has not increased in price.

There are many motorists who believe that their cars run better when using a particular brand of fuel - even though logic tells them that the fuel has probably come from the same tank in the same refinery as competing brands of fuel.

Advertising agencies work very hard to promote what is called "Product Differentiation" - highlighting real or perceived differences between similar products.

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