Determinants of Price Elasticity

There are three major influences on price elasticities: (1) the extent to which a good is considered to be a necessity; (2) the availability of substitute goods to satisfy a given need; and (3) the proportion of income spent on the product. A relatively constant quantity of a service such as electricity for residential lighting will be purchased almost irrespective of price, at least in the short run and within price ranges customarily encountered. There is no close substitute for electric service. However, goods such as men's and women's clothing face considerably more competition, and their demand depends more on price.

Similarly, the demand for "big ticket" items such as automobiles, homes, and vacation travel accounts for a large share of consumer income and will be relatively sensitive to price. Demand for less expensive products, such as soft drinks, movies, and candy, can be relatively insensitive to price. Given the low percentage of income spent on "small ticket" items, consumers often find that searching for the best deal available is not worth the time and effort. Accordingly, the elasticity of demand is typically higher for major purchases than for small ones. The price elasticity of demand for compact disc players, for example, is higher than that for compact discs.

Price elasticity for an individual firm is seldom the same as that for the entire industry. In pure monopoly, the firm demand curve is also the industry demand curve, so obviously the elasticity of demand faced by the firm at any output level is the same as that faced by the industry. Consider the other extreme—pure competition, as approximated by wheat farming. The industry demand curve for wheat is downward sloping: the lower its price, the greater the quantity of wheat that will be demanded. However, the demand curve facing any individual wheat farmer is essentially horizontal. A farmer can sell any amount of wheat at the going price, but if the farmer raises price by the smallest fraction of a cent, sales collapse to zero. The wheat farmer's demand curve—or that of any firm operating under pure competition—is perfectly elastic. Figure 5.2 illustrates such a demand curve.

The demand for producer goods and services is indirect, or derived from their value in use. Because the demand for all inputs is derived from their usefulness in producing other products, their demand is derived from the demand for final products. In contrast to the terms final

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