# ECN(5).pdf - 5 Determinants of the price elasticity of...

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Unformatted text preview: 5. Determinants of the price elasticity of demand Aa Aa E Consider some determinants of the price elasticity of demand: 0 The availability of close substitutes (substitutability) . Whether the good is a necessity or a luxury 0 How broadly you define the market . The proportion of a consumer‘s income it takes to purchase the good A good with many close substitutes is likely to have relatively elastic J demand, since consumers can easily choose to purchase one of the close substitutes if the price of the good rises. Explanation: Close A Price elasticity of demand measures how responsive to changes in price the quantity demanded of a good is. The consumption of goods with relatively elastic demand is fairly responsive to changes in price. The consumption of goods with relatively inelastic demand is not very responsive to changes in price. If a good has several close substitutes, then many consumers will respond to an increase in the price of the good by purchasing one of those close substitutes. For example, many people believe that Coke and Pepsi are close substitutes for each other. Therefore, if the price of Coke were to increase, many consumers would decide to switch to Pepsi. The demand for Coke is relatively elastic. By contrast, there are no close substitutes for insulin as a treatment for diabetes. As a result, an increase in the price of insulin will not lead to a large decline in insulin consumption. The demand for insulin is relatively inelastic. Price elasticity of demand for a good depends on the price of the good relative to the consumers' incomes. Of the following goods, which one has the most elastic demand? 0 Salt 0 Laundry detergent \I 0 TV and internet service plan 0 Lighter ﬂuid Explanation: Close A Other things being equal, the higher the price of a good relative to consumers' incomes, the greater the price elasticity of demand. Hence, the price elasticity of demand for low-priced items, such as salt and laundry detergent, tends to be lower than the price elasticity of demand for relatively expensive items that represent a significant fraction of annual incomes for most families, such as a TV and internet service plan. Be sure to consider not just the price, however, but also the overall portion of a consumer's budget spent on an item. For example, one latte costs only \$3.00, but for daily coffee drinkers, the annual expense could be around \$1,000. The elasticity of demand for lattes is therefore likely to be higher than that for other low-priced items (such as salt) that may need to be purchased only a few times annually. ...
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