DETERMINANTS OF PRICE ELASTICITY OF DEMAND

Demand for a good is a multivariate function. The following are the major factors determining the demand for a commodity.

1. Substitutes of the commodity: 
A commodity having several close substitutes is likely to have elastic demand as the substitution effect would be strong in the case of close substitutes. If its price goes up, consumers buy less of the commodity and more of its substitutes. If its price goes down, consumers desert the substitutes and buy the commodity in relatively much larger quantities. The larger the number of close substitutes the more elastic is the demand for a commodity. The more perfect the substitutes, then its elasticity of demand is near to perfect, or infinite. For this reason, price elasticity of demand for a brand of a product is higher than that for the product as a whole.

2. Nature of the Commodity: Nature of the commodity is an important determinant of the price elasticity of demand. Necessities like food items and prestige goods have an inelastic demand, while luxuries and comforts have comparatively elastic demand.
3. Position of Commodity in the Buyer’s Budget:Importance of a commodity in the buyer’s budget also influences its elasticity. Importance means the portion of total expenditure devoted to a single commodity. The demands for soap, salt, matches, ink, and for many other similar commodities are highly inelastic because the typical household spends only a few rupees a week on each of them. The percentages of family budgets devoted to such commodities are exceedingly small. The demand for such commodities is highly inelastic, but not perfectly inelastic. This is because of the magnitude of the income effect.
The higher the proportion of income spent on a good, the more the consumption will be reduced when its price rises: the bigger will the income and the more elastic will be the demand. Thus salt has a very low price elasticity of demand. Partly because there is no close substitute and partly because we spend such a tiny fraction of our income on salt that we would find little difficulty in paying a relatively larger percentage increase in its price: the income effect of a price rise would be very small. By contract there will be much bigger income effect when a major item of expenditure rises in price. For example, if mortgage interest rates rise ( the price of loans for house purchase), people may have to cut down substantially their demand for housing- being forced to buy somewhere much smaller and cheaper, or to live in rented accommodation.

4. Time Period: When price rises consumers may take a time to adjust their consumption patterns and search for other goods. The longer the time taken after a price change, the more elastic will be the demand. For example, between December 1973 and June 1974 the price of crude oil increased four times. This led to similar rise in prices of petrol and central- heating oil. Over the next few months, the consumption of oil products reduced negligibly Demand was highly inelastic. Motorists had no alternative fuel to which they could turn. All they could do was to cut the number of journeys and try to drive their cars more economically. Likewise, those with oil-fired central heating could not suddenly burn gas or coal in their boilers. All they could do was to turn their heating down. Over time, however, as prices of oil persisted at the high level, new fuel-efficient cars were developed and many people switched to smaller cars. Similarly, people switched to gas or solid fuel central heating, and spent grater amount on insulating their houses to economize on fuel bills. In the long run demand was much more elastic

5. Number of Uses of a Commodity

The more uses a commodity can be put to, the more elastic its demand. It a commodity has only a few uses, its demand is likely to be inelastic. The various uses of any commodity can be thought of. If the price of a commodity is very high, consumers will put it only to the most important use of the commodity. At successively lower prices, more of the commodity is bought, and some units are devoted to the less important uses The greater the number of uses to which a commodity can be put the greater its price elasticity of demand will be. For example, milk, which can be used in making curd, sweets, ice cream, cream, ghee etc. will have high price elasticity of demand. When its price rises, it will be put to only most important use. On the other, when its price declines it will be applied to many less important uses and as a result its quantity demanded will increase significantly. Any judgment of the elasticity of the demand for a commodity must take all determinants into account. They can either reinforce one another or work in opposite directions. A commodity can have several uses but no close substitutes. Another commodity with many substitutes can have a low position in consumer’s budget.The concept of price elasticity of demand is very useful for decision- making. Its major significance lies in price determination.