Management Lite & Ezy 44 – Economics 102

(101 is here.)

Demand of a product or service can be either elastic or inelastic. If it is inelastic, quantity demanded varies little even when the price changes significantly. The graph below shows the curves for elastic and inelastic demand:

One “classic” example of inelastic demand is that of cigarette. Smokers do not quit smoking simply because the government slaps a “sin tax” on cigarettes.

Price elasticity of demand is affected by a few factors, such as:

Availability of substitutes For example, demand for Chevrolets is likely to be very price elastic because of competition from Toyota, Honda, Nissan, Ford, Hyundai etc. Demand for Microsoft Windows, on the other hand, is more inelastic. While Linux and Mac OS are the potential substitutes, switching barrier is often too high.

Durable goods Demand for durable goods tends to be more price elastic than the demand for non-durables. Consumers of durable goods are often in a position to wait for a more favorable price, a sale, or a special deal when buying these items. This accounts for some of the volatility in the demand for durable goods.

Percentage of budget Demand for relatively high-priced goods tends to be more price elastic. This is because expensive items account for a greater proportion of a person’s income and potential expenditures than do low-priced items.

Time frame of analysis Over time, demand for many products tends to become more elastic because of the increase in the number of effective substitutes. For example, in the short run, demand for gasoline may be relatively price inelastic because the only available alternatives are not taking a trip or using public transport. Over time, as consumers replace their cars, they may opt for vehicles which are more fuel-efficient such as the Toyota Prius which runs on hybrid engine.

Reference:

James McGuigan, Charles Moyer & Frederick deB Harris, Managerial Economics: Applications, Strategy, and Tactics, 9^th edition