An explanation of the determinants of the price elasticity of demand as part of the price elasticity of demand simulation in the Virtual Learning Arcade.
Spotlight on the Theory
Determinants of the Price Elasticity of Demand (PED)
The price elasticity of demand measures how responsive the quantity demanded of a good is to a change in its price. The value illustrates if the good is relatively elastic (PED is greater than 1) or relatively inelastic (PED is less than 1).
A good's PED is determined by numerous factors, these include;
- Number of substitutes: the larger the number of close substitutes for the good then the easier the household can shift to alternative goods if the price increases. Generally, the larger the number of close substitutes, the more elastic the price elasticity of demand.
- Degree of necessity: If the good is a necessity item then the demand is unlikely to change for a given change in price. This implies that necessity goods have inelastic price elasticities of demand.
- Price of the good as a proportion of income: It can be argued that goods that account for a large proportion of disposable income tend to be elastic. This is due to consumers being more aware of small changes in price of expensive goods compared to small changes in the price of inexpensive goods.
The following example illustrates how to determine the price elasticity of demand for a good.
The price elasticity of demand for supermarket own produced strawberry jam is likely to be elastic. This is because there are a very large number of close substitutes (both in jams and other preserves), and the good is not a necessity item. Therefore, consumers can and will easily respond to a change in price.