The Price Elasticity of Demand and Its Determinants

The law of demand states that a fall in the price of a good raises the quantity demanded. The price elasticity of demand measures how much the quantity demanded responds to a change in price. Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price- Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price.

The price elasticity of demand for any g<xxi measures how willing consumers are to buy less of the good as its price rises. Thus, the elasticity reflects the many economic, social,and psychological forces that shape consumer preferences. Based on experience, however, we can state some general rules about what determines the price elasticity of demand.

Availability of Close Substitutes Goods with dose substitutes tend to have more elastic demand because it is easier for consumers to switch from that g<x»d to others. For example, butter and margarine are easily substitufable. A small increase in the price of butter, assuming the price of margarine is held fixed, causes the quantity of butter sold to fall by a large amount. By contrast, because eggs are a fixxj without a close substitute, the demand for eggs is less elastic than the demand for butter.

Necessities versus Luxuries Necessities tend to have inelasticdemands, whereas luxuries have elastic demands. When the price of a d<>ctor's visit rises, people will not dramatically reduce the number of times they go to the doctor, although they might go somewhat less often. By contrast, when the price of sailboats rises, the quantity of sailboats demanded falls substantially. The reason is that most people view doctor visits as a necessity and sailboats as a luxury. Of course, whether a good is a necessity or a luxury depends not on the intrinsic properties of the good but on the preferences of the buyer. For avid sailors with little concern over their health, sailboats might be a necessity with inelastic demand and doctor visits a luxury with elastic demand.

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