Explain how each of four different factors can affect the price elasticity of demand. Give an example for each determinant.
The availability of close product substitutes- When a given product has many close substitutes, it becomes easier for consumers to switch brand loyalty basing their decisions on the market prices of the substitutes. This makes products with many close substitutes to have a higher price elasticity of demand. For example, coffee and tea can be considered as close substitutes. A large increase in the price of tea would make consumers to prefer buying coffee, thereby reducing the demand for tea.
Income proportion spent on a given good – It is observed that those goods that take up a big proportion of consumers’ income tend to have a higher price elasticity of demand than those requiring less expenditure. For example, a change in the price of vehicles and real estate property would have a larger impact on the customers’ decision to change preference. In comparison, a change in the price of salt may have little or no effect on the levels of demand.
Degree of product necessity – those goods considered to be necessities often tend to have inelastic demand as compared to luxury goods. For example, a change in the price of flour as a staple food would have little effect, if any, on its overall demand. In comparison, an increase in the price of a luxury personal car may be accompanied by increased loyalty shifts to other competing car models offering lower prices.
Time available for consumer adjustment to price change– the amount of time available for a product’s consumers to respond after a price change may also determine the level of price elasticity of demand. If the time is too short, the consumers may not have the option to shift their product preference, consequently creating an inelastic demand pattern for the product. When the time to shift is long enough, the consumers would move on to other products with favorable prices, making a specified product’s demand to be highly elastic.
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