Determinants of the Degree of Elasticity of Demand

What makes demand elastic (figure 6) or inelastic (figure 5):

1. The most important influence is the availability of substitutes. A relatively small percentage increase in price leads to a large percentage decline in quantity demanded.

2. If the product is a necessity rather than a luxury, its demand will tend to be more inelastic.

3. The product's cost relative to the buyer's income.

4. The number of uses a product has affects the elasticity of its demand. The more uses, the higher the elasticity.

5. Advertising.

 

 

 

Figure 5. Relatively inelastic demand

 

Figure 6. Relatively elastic demand

Advertising attempts to change the way we think about a product. It tries to make us think a product is more useful, more desirable, or more of a necessity. Ideally, an ad will make us feel we must have that product. To the degree that advertising is successful; the demand curve is made steeper and is pushed farther to the right (from D₁ to D₂) in Figure 7.

 

 

Figure 7. Result of successful advertising.

 

Cross Elasticity of Demand

 

We calculate the coefficient of cross elasticity of demand E_xy just as we do the coefficient of simple price elasticity, except that we relate the percentage change in the consumption of product X to the percentage change in the price of product Y:

E_xy = percentage change in quantity demanded of product X

percentage change in price of product Y

This cross elasticity concept allows us to quantify and more fully understand substitute and complementary goods.

Substitute Goods. If cross elasticity of demand is positive—that is, the quantity demanded of X moves in the same direction as a change in the price of Y— then X and Y are substitute goods.

Complementary Goods. When cross elasticity is negative, we know that X and Y "go together"; an increase in the price of one decreases the demand for the other. So these two are complementary goods.

Independent Goods. A zero or near-zero cross elasticity suggests that the two products are unrelated or independent goods.

 

Income Elasticity of Demand

 

Income elasticity of demand measures the degree to which consumers respond to a change in their incomesby buying more or less of a particular good. The coefficient of income elasticity of demand E_i is determined with the formula:

E_i = percentage change in quantity demanded

percentage change in income

Normal Goods. For most goods the income elasticity coefficient E_i is positive, meaning that more of them is demanded as incomes increase. Such goods are called normal or superior goods. But the value of E_i varies greatly among normal goods.

Inferior Goods. A negative income elasticity coefficient designates an inferior good. Retreaded tires, cabbage, long-distance bus tickets, used clothing, and muscatel wine are likely candidates. Consumers decrease their purchases of such products as incomes increase.

Insights. Income elasticity of demand coefficients provides insights about the economy.

Table 2

Cross and income elasticities of demand

Value of coefficient	Description	Type of good(s)
Cross elasticity: Positive (Ewz>0)     Negative (Ewz<0)	Quantity demanded of W changes in same direction as change in price of Z   Quantity demanded of X changes in opposite direction from change in price of Y	Substitutes     Complements
Income elasticity: Positive (Ei > 0)     Negative (Ei < 0)	Quantity demanded of the product changes in same direction as change in income   Quantity demanded of the product changes in opposite direction from change in income	Normal or superior     Inferior

 

Individual Supply and Market Supply

 

Supply is a schedule of quantities of a good or service that people would be willing to sell at various prices.

Market supply is the sum of the supplies of all the firms in a given market.

 

Elasticity of supply

Percentage change in quantity supplied = Q₁ - Q ₂ x P₁+ P₂
Percentage change in price Q₁ + Q₂ P₁ - P₂

Figure 6 shows a perfectly elastic supply curve, which is exactly the same as a perfectly elastic demand curve.

Figure 7 shows a perfectly inelastic supply curve, which would be identical to a perfectly inelastic demand curve.

 

Figure 6. Perfectly elastic supply curve

 

Figure 7.Perfectly inelastic supply curve

Figure 8 shows relative elasticity of supply.

Figure 8. Relative elasticity of supply