Elasticity in Economics: 5 Factors That Influence Elasticity

When presenting the principles of supply and demand, economists frequently make qualitative remarks about consumer and producer behavior. According to the law of demand, as the price of a good or service rises, the demand for that good or service falls. According to the law of supply, the quantity of an item produced grows in proportion to its market price. While these rules are valuable, they do not encompass everything that economists would like to include in the supply and demand model; as a result, economists have devised quantitative measurements like elasticity to provide more information about market behavior.

 

Factors that influence Elasticity

 

Price elasticity of demand is a measure of how much demand changes as a product's price changes. Elastic demand occurs when a price adjustment results in a significant shift in demand. Inelastic demand occurs when a price adjustment results in a minor change in demand.

 

Some of the factors that influence elasticity are-

 

1. Availability of substitutes

 

The more quickly a customer can switch from one product to another, the more elastic demand for that product will be. For example, if customers enjoy both coffee and tea equally, they will be pleased to switch to tea if the price of coffee increases. When this occurs, the demand for coffee will decrease. This is due to the fact that coffee and tea are often used interchangeably.

 

2. Urgency

 

The more discretionary a purchase is, the less demand it will have in the face of price increases. That is, product demand is more elastic. Assume you want to buy a new washing machine, but your present one is still functional; it's just old and obsolete. If the cost of a new washing machine rises, you are more likely to postpone the purchase until prices fall or the present machine breaks down.

 

3. Availability of Substitutes

 

The availability of substitutes significantly impacts demand elasticity. The availability of competing substitutes is the primary explanation for changes in the elasticity of demand as prices fluctuate for some items. The bigger the number of close alternatives for a good available in the market, the higher its elasticity. Tea and coffee are good examples of near alternatives. If the price of tea rises, people may reduce their intake of tea and instead buy coffee, and vice versa. In such a circumstance, demand for tea falls while demand for coffee soars. As a result, the elasticity of demand for both of these products would be larger.

 

4. Level of Price

 

The term "Level of Price" refers to the inelastic demand for high-priced commodities like gold and diamond jewellery and foreign cars. A change in the price of these commodities results in a relatively little change in their demand. Similarly, demand for low-cost commodities, such as inexpensive potatoes and match boxes, is inelastic.This is because consumers have already purchased these commodities in sample quantities; thus, a change in price creates a little change in demand. 

 

5. Complementary Goods

 

The demand for related goods is relatively inelastic. The complementary items, pen and ink, and car and petrol, are consumed together. As a result, a rise in the price of one commodity will have no effect on its demand unless the price of the complementary good changes. For example, if the price of gas rises, demand will not fall immediately until the price of the automobile rises.

 

Also Read | Six Types Of Elasticity Of Demand In An Economy

 

Examples of Elasticity

 

When a product is elastic, a change in price immediately causes a change in the amount demanded: When prices fall, demand rises, and when they rise, demand falls. Spa days, for example, are extremely elastic since they are not an essential product; increasing the cost of spa visits will result in a bigger decrease in demand for such services. In contrast, a fall in price will result in a bigger than proportional increase in demand for spa treatments.

 

There are several real-world examples of flexibility that consumers deal with on a regular basis. Uber's surge pricing is a fascinating current example of price elasticity of demand. Uber employs a "surge-pricing" algorithm when there are an unusually high number of users requesting rides in the same geographic location. The company uses a pricing multiplier, which allows Uber to raise prices in real time based on demand.

 

The COVID-19 pandemic had an impact on the price elasticity of demand in various businesses. COVID-19 outbreaks at meat processing facilities around the United States, along with a halt in foreign trade, caused a domestic beef shortage. This prompted import costs to climb by 16% in May 2020, the highest increase since 1993.

 

The oil industry was also affected by the COVID-19 epidemic. Although oil is normally relatively inelastic, crude petroleum traded at a negative price in the futures market on April 20, 2020, due to an unprecedented reduction in global demand for oil between March and April, as well as increasing supply and a lack of storage capacity. In reaction to this severe decline in demand, OPEC countries decided to reduce production.

 

Limitations of calculating elasticity

 

While elasticity is an important economic tool, it is not without its complications. Understanding these problems is critical for anyone working with economic data.

 

1. Data Collection

 

Elasticity calculations require detailed data on price and quantity demanded changes. Collecting such data can be difficult, especially in huge markets with various customer behaviors. Businesses frequently spend time in market research to gather accurate data.

 

2. Other considerations in play

 

Elasticity simplifies economic processes by focussing simply on the price-demand relationship. However, in real-world circumstances, a variety of additional factors can influence demand, including changes in consumer income, preferences, and external events such as economic downturns or natural catastrophes. Elasticity models often assume ceteris paribus, or "all other things being equal," although this is rarely true in fact.

 

Conclusion

 

To summarize, elasticity is a powerful concept that informs economic decision-making. Understanding how demand responds to price changes allows businesses to develop pricing strategies that maximize profits, while consumers may plan their purchases carefully. However, elasticity varies among marketplaces and is impacted by factors such as substitute availability and time horizon. While elasticity models can provide useful insights, they should be utilized in conjunction with a more comprehensive understanding of market dynamics.

 

Elasticity is an economic concept that describes how one economic variable responds to changes in another. It is commonly used to describe how demand for a product changes in response to price changes, also known as price elasticity of demand. 

 

Demand is considered to be inelastic when demand for a good or service is generally static (it does not change), even when the price varies; if a good or service is required for survival or comfort, people will continue to pay higher prices for it. Caffeine and petrol are examples of inelastic products. When a product is elastic, a price change immediately affects the quantity demanded. Clothing and electronics are examples of elastic products.

 

Also Read | 5 Factors Affecting the Price Elasticity of Demand (PED)