Chapter 5
5.7 Factors affecting the price elasticity of demand

1.
2.
3.
4.
5.
6.
There are 6 factors affecting the price elasticity of demand:
Availability of substitutes
Classification
Expenditure share of income
Temporary or permanent change in price
Time
Nature of the good
Availability of substitutes

In a one-good world, price elasticity of demand is always equal to –1 as the total revenue
remains unchanged.

When X has many substitutes, an increase in the price of X will allows us to switch to its
substitutes.

The price elasticity of demand increases with the availability of substitutes.
Classification

A group that includes more items generally has a lower elastic price elasticity of demand than
the sub-group or an item of the group.
Compare the good of the same category. You annot compare the price elasticity of demand
between food and pencil as pencil does not belong to the category of food.
Expenditure share of income

When our expenditure on X is small relative to our total income, an increase in the price of Y
will not lower our purchasing power very much. Hence, the income effect is small.


The reduction in the quantity demanded for Y due to income effect will be relatively small.
The price elasticity of demand increases with the expenditure share of income on the good.
Temporary or permanent change in price

When the change in price is temporary, the response is larger as we expect the price to increase
in the near future.

When the change in price is permanent, the response is smaller as we do not expect the price to
increase in the near future.

The shorter the sale, the larger is response to the sale. Hence, the price elasticity of demand is
larger.
Time

The longer period the market is defined, the longer the time for customers to respond to the
change in price.

The price elasticity of demand increases with the time horizon.
Nature of the good

For necessities, we do not change quantity demanded very much when there is a change in
price. For luxuries, we are more sensitive to price changes.

The price elasticity of demand of luxuries is higher than that of necessities.
5.10 Factors affecting the price elasticity of supply

1.
2.
There are 4 factors affecting the price elasticity of supply:
Technology
Share of input market
3.
4.
Time
Geographical scope of market
Technology

If increased production is expensive, the supply curve is inelastic. If increased production is
cheap, the supply curve is elastic.

Technology advancement reduces the marginal cost of production. Hence the price elasticity of
supply increases when there is technology advancement.
Share of input market

Supply is elastic when the industry can be expanded without causing a significant increase in
the demand (and price) for the industry’s inputs.

Supply is inelastic when industry expansion causes a significant increase in the demand (and
price) for inputs.

If we can mobilize the input from the production of other processes to the production of X, the
price elasticity of supply is higher.

The smaller share of input market, the more effective the mobilization of input. Hence, the price
elasticity of supply decreases with the share of input market.
Time

The longer period the market is defined, the longer the time for customers to respond to the
change in price.

The price elasticity of supply increases with the time horizon.
Geographic scope of market

The larger the geographic scope of the market, the fewer inputs from other regions can be used
for moblization.

The price elasticity of supply decreases with the geographic scope of the market.