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Determinants of Price Elasticity of Demand


Determinants of Price Elasticity of Demand

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now, let's discuss what causes different products to have different elasticity of demand. So you can imagine that the price elasticity of demand for, say, a pack of gum is gonna be different than for a house or a pizza or anything for that matter, Right? So what causes the price elasticity to be what it is? So we're gonna discuss these determinants, which is things that determine the price elasticity. The first one and probably the most important one is close substitutes, the availability of close substitutes, Right? So when a product has a lot of close substitutes, um it's gonna have a more elastic demand. Okay, And that kind of makes sense, right? Because if a price change happened and there's a lot of substitutes, say in the fruit market, right? Um if you if the price of apples goes up, you would not buy more apples. You buy oranges instead or something like that. Right? The idea that you're more affected to price, the quantity demanded is gonna shift a lot in markets where there's a lot of close substitutes. So somewhere where there's not close substitutes, something maybe like utilities, right? Uh your utility bill, if they change the rate of your electricity, there's not so much you can do about it, right? You're kind of stuck with that company. There's not really too many choices for your power bill. Um So when there's not so many options, it's going to be less elastic, the price goes up and the quantity demanded is not gonna change as much as that price change, right? As compared to close substitutes? Something like I said, like let's say apples and oranges, right? Where a price goes up of apples and you're gonna buy oranges instead, right? That's what's gonna happen. And the quality demand of apples is gonna drop a lot compared to that price change. So it's gonna be more elastic in that sense. The next one is necessities versus luxuries, so luxury items tend to have more elastic demand. Alright, and this should this should all be a little bit intuitive as well, right? You could imagine that something that you need, you're not you're gonna be pretty in elastic, you're gonna kind of buy it whether the price goes up, something like food, right? If the price of food goes up, you're probably still gonna buy food because you because you need it, right? The quantity demanded isn't going to shift as much as the price there as compared to a luxury item, maybe something specific like cab er right, this luxury food or something like that, when the price goes up of caviar, you're probably gonna buy less of it because you were only buying it because it was a luxury item. Anyways, right? So when the price goes up for these luxury items, you didn't need it, you'll be like, well, you know, maybe I shouldn't spend my money there, um I'll spend it on something else. So luxury items tend to have more elastic demand in that same sense. Alright let's go on to the next one definition of the market. So when we define the market narrowly, um you're gonna have more elastic demand. So what does that mean to have a narrow market definition versus a wide market definition? So narrow market definition could be something like apple's the market for apples compared to a wide market definition, which could be the market for four fruit in general. Right? So you can imagine that apples is going to have a more elastic demand than fruit, just like in our previous example, if the price of apples went up, you might buy an orange instead, right? So the demand for apple's might have changed quite a bit, but for fruit in general, you're still buying fruit, right? You just substituted an apple for an orange. So in the fruit market we define it wider. Right? There wasn't a change there as compared in the apple market where um when the price went up for apples, you went to something else. So it's just an interesting thing to note that how we define the market is going to define the elasticity as well. Cool. Another one here, the time horizon. So in the long run goods tend to have more elastic demand. So what is the short run? And the long run we think of the long run as, you know the um amount of time that it takes to adapt to these price changes. It's not really long run is five years, It's not something so clear cut, it's just like, how long will it take to adapt to these changes. So in the short run, we don't have enough time to adapt. So I think a good example for the short run, in the long run, I'm gonna say gasoline, right in the short run, let's say the price of gas starts going up a lot, right? You see, still have your car, you kind of dependent on gas. You're not really gonna be able to change your demand. Your demand is gonna be pretty in elastic for gas in the short run. But if those prices stay high, you're gonna start thinking of alternatives, right? You might sell your car and buy a hybrid, right? Or maybe buy a bicycle, right? You're gonna change your demand in the long run so that you don't need the gas as much. So in the long run, you're gonna, your demand for gas is going to be more elastic because you can change what you need, right? You can change how you demand stuff, but in the short run, you're kind of stuck, you're dependent. You gotta get to work and get to school, you have your car, but over time, right? You could find out the bus schedules or whatever by a hybrid, etcetera. So the long run, you're gonna have more elastic demand, You're gonna be able to change out how you demand stuff and last but not least, we've got the share of a consumer's budget. Good. Using up a large share of a consumer's budget, have more elastic demand. So you can imagine something that has a small share of your budget, something like, say, a pack of gum or something like that. You know, if you chew gum all the time and gums, 50 cents for a pack and now gum went up to 60 cents, you're gonna be like, oh, that sucks, but you'll probably still by the gum, right? 50 cents, 60 cents. It's not a big deal to you, uh compared to something like a house, right? When you're in the market for a house And you're looking for something that costs $100,000. And now prices have been rising and there are $150,000 that's gonna make a much bigger difference to you, right? So share of the budget is another one there. Cool. So that is the determinants of price elasticity of demand. Let's move on.