Consumers in a market economy are influenced by various factors in deciding what to buy. One of these factors is price, and the law of demand that defines the typical relationship between price and quantity demanded states that consumers will demand more of a particular product at a lower price, and less at a higher price. However, the price elasticity of demand extends this and examines the extent of such changes in demand in relation to price.
When you raise the price of most items, people will buy less of them. For example, when one airline raises its price, air passengers may switch to a rival airline. When you lower the price of most items, people will buy more of them. For example, the falling price of computers has meant that increasing numbers of families and businesses have bought them.
Common sense tells us that when prices change, so too will the quantities bought. However, businesses need to have more precise information than this - they need to have a clear measure of how the quantity demanded will change as a result of a price change.
The degree to which a demand or supply curve reacts to a change in price is the “Price Elasticity of Demand” elasticity. Elasticity varies among products because some products may be more essential to the consumer. Products that are necessities are more insensitive to price changes because consumers would continue buying these products despite price increases. Conversely, a price increase of a good or service that is considered less of a necessity will deter more consumers because the opportunity cost of buying the product will become too high.
How sensitive is the demand for a product to a change in the real incomes of consumers? We use “Income Elasticity of Demand” to measure this. The results are important since the values of income elasticity tell us something about the nature of a product and how it is perceived by consumers. It also affects the extent to which changes in economic...