The cost of goods and services is always in flux in a market ecosystem due to the rising or declining tendencies of demand and supply. However, to understand what is meant by the price elasticity of demand, we have to focus exclusively on demand itself.
The law of demand states that when the price of a commodity changes, its demand also changes. However, this change varies between different products. For example, products like washing machines and automobiles have a significant change in demand when the price changes. On the other hand, products like fuel and medicines have a minor change in demand. The price elasticity of demand measures how sensitive the demand is to the change in the price of a commodity.
Multiple factors influence the nature of the commodity, making the demand for some commodities elastic or inelastic.
If a product has substitutes, a price increase leads to a decrease in demand as consumers switch to similar products. This makes demand for substitute products more sensitive to price changes, leading to competitive pricing to retain customers. In contrast, products with no substitutes, like electricity, have inelastic demand since consumers have no alternatives.
Necessities have inelastic demand, e.g., medications, while luxury goods have more elastic demand, e.g., high-end fashion accessories.
The income of consumers affects price elasticity of demand. Lower-income consumers are more sensitive to price increases, causing a greater impact on demand and making it more elastic for them. For example, if the price of milk rises, a low-income household would limit their milk consumption, but a high-income household may not be affected as much.
Perishable goods have inelastic demand as consumers cannot delay consumption when prices increase. Durable goods have elastic demand because consumers can postpone purchases or buy in bulk when they expect prices to rise. Therefore, many consumers wait for newly launched laptops to drop in price to save money.
Consumer habits can depict the price elasticity of demand too. Loyalty towards a particular brand or product could create an inelasticity of demand, e.g., a large portion of Apple users have high brand loyalty and would opt to buy an Apple product even if its price rises.
Formula for calculating the price elasticity of demand is:
It can be expanded to the following equation:
Example of calculating the price elasticity of demand with the formula:
The demand is unitarily elastic when the elasticity coefficient (PED) is 1. This means that a 1% change in quantity occurs for every 1% change in price. In the real world, the PED is rarely equal to 1. When the demand is elastic, the elasticity coefficient (PED) is greater than 1, and when the demand is inelastic, the coefficient (PED) is between 0 and 1.
Cross-price elasticity of demand occurs when the demand for one commodity is affected by the price of another. If the demand for masoor dal grows when the price of tur dal goes up, that's positive cross-price elasticity. Conversely, if the demand for ink cartridges goes down when the price of printers goes up, that's negative cross-price elasticity.
Price elasticity is important for understanding consumer behavior and market dynamics. It can help with analyzing competition and forecasting revenue. This knowledge can assist businesses, policymakers, economists, and investors in making informed decisions that can impact pricing strategies, profits, and market interventions.
It helps businesses to know the impact of price on profitability. It is also useful for policy-making decisions like taxation and regulation.
When BEST buses in Mumbai reduced the price of their tickets, more travellers started using BEST buses. The demand for salt is an example of the inelasticity of demand. Though the price of salt has increased, demand hasn’t fallen due to it.
The price elasticity of demand mainly depends on the nature of goods and services, the availability of substitute products, the income of the consumers, etc.
