1) (a) With the use of examples, explain why some products have a low price elasticity while others have a high elasticity.
Generally, elasticity measures “how much one factor changes in response to a change in a different factor.” Furthermore, the price elasticity of demand (PED) measures “the responsiveness/sensitivity of consumers to a change in the price of a particular product”. We can determine this sensitivity of consumers to price changes or whether demand for a particular product has a low (inelastic) or high price elasticity (elastic), with the following factors:
- More substitutes the product has, the higher price elasticity.
- Proportion of income
- Goods that make up a large proportion of a consumers income tends to have a high price elasticity
- Because a certain percentage change in price will appear much larger to the consumer than the same percentage change in price of a good that makes up a very small proportion of income.
- Luxury or necessity
- Goods that are a necessity to consumers = low price elasticity
- Luxury goods, products consumers can live without when price rises = high price elasticity
- Addictive or not
- Addictive goods tends to have = low price elasticity
- E.g. tobacco, drugs, alcohol, and fatty/salty food
- Time to respond
- Goods that have increased in price in the short run = low price elasticity
- Goods that have increased in price in the long run (more options)= high price elasticity
The lower the price of elasticity, the less influence the change in price of the product has on the quantity demanded and supplied. Most of these low price products are essential to consumers and have less substitutes, thus the consumers are less sensitive to the change in the products price. Examples include: oil (gasoline), diamonds, tobacco, and staple foods (rice). On the other hand, products with a high price elasticity suggests that consumers are more sensitive to the change in price of the goods/service. So, goods with a high price elasticity are considered have many substitutes and are not essential, like: movie ticket, butter, and smartphones. This means, consumers will have a greater influence when there is a change in price and will most likely switch to buy its substitute good instead.
(b) If you were employed as an economists by a business, discuss why a knowledge of the price elasticity of demand of your product would be useful.
A knowledge of the price elasticity of demand of my product would be useful since I can determine how much of the product to supply with the understanding of its high or low price elasticity. Say for example my product was butter; since this product has a high elasticity of demand, a change in price will have a great impact on the quantity demanded by the consumers. Thus, I will have to make sure the price of butter is constant or cheaper than any other substitute goods (like margarine) so the quantity demanded will not decrease. Although if my product was tobacco, I may increase the price of the good knowing that the product has a low price elasticity of demand. Since the change in price of low price elasticity goods have less influence on consumers, raising the price of tobacco may not change the quantity demanded of the good. Altogether, having an understanding of the price elasticity of demand will allow me to efficiently determine the product’s quantity supplied and its most suitable price.
Cross-price elasticity: the responsiveness of consumers of one good to change in the price of a related good.
Income elasticity: the responsiveness of a consumer’s demand for a particular good to a change in the consumer’s income
Price elasticity: the responsiveness of producers to changes in price.