factors affecting: price elasticity of demand

Price Elasticity of Demand 📈

Think of price elasticity like a rubber band. If the band stretches a lot when you pull it (high elasticity), the quantity demanded changes a lot when price changes. If it barely stretches (low elasticity), quantity demanded stays almost the same even if price moves.

Key Formula

$E_d = \dfrac{\% \Delta Q_d}{\% \Delta P}$

Interpretation:

• $|E_d| > 1$ → Elastic demand (big change in quantity)
• $|E_d| = 1$ → Unit‑elastic demand (proportional change)
• $|E_d| < 1$ → Inelastic demand (small change in quantity)

Factors That Make Demand More Elastic

• Many substitutes available (e.g., Pepsi vs. Coke)
• Goods are a large part of budget (e.g., fancy cars)
• Time horizon is long – people can change habits
• Goods are non‑essential or luxury items
• High proportion of income spent on the good

Factors That Make Demand Inelastic

• Few or no substitutes (e.g., insulin)
• Essential goods (e.g., basic food)
• Short‑term time horizon (people need the product now)
• Low proportion of income spent on the good

Income Elasticity of Demand 💰

Income elasticity tells us how quantity demanded changes when people's income changes. Imagine you get a raise and decide how much of a product to buy.

Key Formula

$E_i = \dfrac{\% \Delta Q_d}{\% \Delta I}$

Interpretation:

• $E_i > 0$ → Normal good (demand rises with income)
• $E_i > 1$ → Luxury good (demand rises faster than income)
• $0 < E_i < 1$ → Necessity (demand rises but slower than income)
• $E_i < 0$ → Inferior good (demand falls as income rises)

Examples

• Luxury cars: $E_i \approx 2$ – demand doubles when income doubles.
• Basic bread: $E_i \approx 0.3$ – small increase with income.
• Fast food: $E_i \approx -0.2$ – people buy less when they earn more.

Cross Elasticity of Demand 🔀

Cross elasticity measures how the demand for one product changes when the price of another product changes. Think of it as a “price‑reaction” between two goods.

Key Formula

$E_{xy} = \dfrac{\% \Delta Q_{d_x}}{\% \Delta P_y}$

Interpretation:

• $E_{xy} > 0$ → Substitutes (price rise of y increases demand for x)
• $E_{xy} < 0$ → Complements (price rise of y decreases demand for x)
• $E_{xy} = 0$ → No relationship

Illustrative Table