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ECN(6).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 without any close substitutes is likely to have relatively inelastic ‘/ demand, since consumers cannot easily switch to a substitute good 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 depends in part on how necessary the good is compared to other goods. If the following goods are priced about the same, which one has the least elastic demand? 0 New sports car 0 Motorcycle ll 0 New life-saving chemotherapy treatment for cancer 0 Sailboat Explanation: Close A When people buy a luxury good like a new sports car, the price of the new sports car and the prices of similar sports cars will be major factors. When people decide whether to purchase a necessary medical treatment, price is much less of a factor—especially if there are no other treatments that could achieve the same result. Since price elasticity of demand measures how responsive buyers are to changes in price, the elasticity of demand for a cancer treatment is likely to be much lower than the elasticity of demand for sports cars. ...
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