Demand And The Price Elasticity Of Demand

The objective is to determine how people respond to changes in prices of factors of production over time. Actually so many people prefer more economic services and goods than not. However, it will never reach a point in our lifetime when so many services and goods produced and distributed will be in excess that we will not need them. We must be rational so that we can manage the limited amount of income to satisfy our many wants especially those with the highest priority. It is therefore irrational to spend money carelessly without giving attention to our income limitations. It is safe to consider carefully other alternative ways of spending our limited earnings in relation to maximum satisfaction.

Most goods can be obtained by sacrificing money or other goods and the sacrifice is measured by the price. Wise choosing of substitutes needs a balancing of additional benefits against additional costs or marginal revenue versus marginal cost. Other items like individual security, transportation, formal education, quality health care and clean air are usually referred to as necessities. However, at some price the difference between wants and necessities become clear. Almost all wants have substitutes but as we define a commodity in a narrow perspective, the more the number of substitutes.

Each consumer will choose from the variety of substitutes based on personal preferences and the related alternative substitutes. Consumers make decisions mainly based on expected additional benefits and costs obtained from available information. Enough information is usually available and since information itself is an economic good.

Factors affecting demand

As per csun.edu, “Demand is the relationship between the price of a good and the quantity of the good that consumers are willing and able to buy.” Demand can be defined as the relationship between the quantities of a good supplied and its price that consumers are willing and can manage buy. Factors to demand come in two parts, which are the individual factors and the market factors. Factors that affect individual demand include the price of a good whereby it is inversely proportional to demand. A reduction in price leads to high demand and the opposite is also true. Another factor that affects individual demand is the consumer income (Ellingson 1977). An increase in the amount of income enables the consumer to demand more goods than they normally do. When inferior goods are available in the market, it makes the consumer having high income to reduce the quantity of goods he demands. The demand for neccessicity goods will not be affected by the change in price (Ellingson 1977).

Prices of related goods like the complimentary or substitutes also affect individual demand. Substitute goods can satisfy the same type of demand and therefore one good can be used in place of the other like in the case of coffee and tea. If the price of coffee increases, people will be forced to buy tea to substitute the coffee and as a result, the demand for tea goes up. On the other hand, complimentary goods are used together or jointly consumed like ink and pen. Increase in the price of ink will lead to automatic decrease in the demand for the pens. In this case, therefore increase in the price of ink results into a negative relationship with the quantity of pens demanded. Preferences and tastes is another factor that affects individual demand. These rely on general lifestyle, social customs, and habits. Fashion that keeps on changing for instance will affect the demand directly. A new and fashionable cloth in the market is more preferred than the ones believed to be less fashionable and these will increase the demand of that product. . These depend on social customs habits of people fashion general lifestyle of people. For instance if Converse shoes are in fashion then consumers will prefer buying that to any other shoe.

If there is a favorable (unfavorable) change in the tastes and preferences of the consumer for the particular type of shoes, it will lead to an increase (decrease) in the demand of the shoes at Famous Footwear.

This happens because the taste and preferences of the consumer is directly related to the demand of the shoes.

The taste and preference of the consumer can be affected by many factors:

a) Advertisements.

b) Consumer Satisfaction

c.) Fashion Trend etc.

Another determinant of individual demand is the consumer expectation. Anticipation for the future increase in prices makes the consumers to demand more of these goods. This appears to be a panic kind of situation by the consumers and therefore will be forced to buy more goods with the perception that the shortage is going to last for a longer period than they expect. In addition, expected increase in income will lead to increase in demand because consumers will buy more. When there is shortage expectation of a commodity, its demand will also reduce. Consumer credit facility is another factor that has enabled consumers to buy very expensive goods that would have not afforded. Bank loans, which are offered to consumers, make it easier to buy expensive luxury goods like cars and houses hence increasing the demand of these goods (Findlay 1980).

Population size and composition is a factor that affects market demand. Large population leads to large amounts of consumers and increase in demand while small populations lead to low demand of a particular commodity. The composition of a population also affects the demand of a commodity in the sense that if the number of females in a population is high the demand for female clothing is also high. High number of males also in a population can increase the demand for shaving devices, which in turn lead to proportional increase in the demand for the devices. These factors are known as the demographic effects on the demand of a commodity. Unequal distribution of income in the country causes the demand of luxury goods like cars to increase, but equal income distribution increases the demand for basic goods and reduces the demand for the luxury goods. Taxes imposed by the government on commodities causes the prices of these commodities to increase resulting into a decrease in demand while grants and subsidies reduce prices and increase the demand. Most of these commodities are of a basic nature where one cannot do without hence the need for the government to intervene to ensure that the commodity is evenly distributed. The government may not have any intention on the results of demand and supply but the act will finally dictate the outcome in terms of supply and demand. Weather and season also affects market demand because during winter season, the demand for woolen clothes is high and during the summer season, the demand is extremely low.

Let us take few more examples:

Demand for small automobiles such as the Mini Cooper and Smart car will be affected in the following manner:

If small automobiles become more fashionable, the demand for small automobiles will increase as taste and preferences are now in favor of small cars.

If the price of large automobiles rises (with the price of small autos remaining the same: The demand for small cars will increase as it large cars become more expensive.

If Income declines and small autos are, an inferior good Decline in Income will lead to increase in demand of small cars as they are considered as inferior goods. People will switch to the small cars.

Exceptions to the law of demand. In Giffen goods, the demand reduces with a decrease in their prices. Consumers spend much of their income in these inferior goods. In this case, the curve for demand is slope positively. These goods are mostly consumed by the low-income earners in the society and any price increase is likely to deplete their income and they are forced to shift their interest in buying giffen goods. Price decrease spares the poor extra money to buy goods that are more expensive. Giffen goods do not have any closely related substitutes making the income effect to be higher than the substitution effect (Findlay 1980)

Articles of snob appeal are goods whose demand increases with the increase in price. It includes commodities such as gold and diamond that are meant for prestige reasons. Increase in their prices increases the prestigious value as well. Future expectation regarding the increase in the price of the commodity will lead to increase in their prices and demand as well. In emergencies, the for instance future expectations of shortage in a particular commodity will lead to high prices for the commodity and high demand so that people can hoard the product. However, in depression the consumers will buy fewer commodities with low prices. The relationship between the price and quality has led to the perception by the consumers that expensive goods are of more quality than the cheap goods and therefore the demand for the expensive goods rises while the cheap goods are neglected. The wealthier members of the society form the driving force behind this phenomenon. Those who cannot afford do not have an alternative but they rather choose to spare their income to buy goods that they will comfortably afford without any pressure.

Factors affecting price elasticity of demand

Elasticity refers to a central concept in the theory of supply and demand and helps us to know how demand and supply respond to a variety of factors such as stochastic principles and prices. Generally, elasticity is the percentage change of a variable divided by the percentage change in another one. Elasticity is a measure of changes of relative nature. It is always necessary to know how the quantity supplied and that demanded change when the price changes. This is referred to as price elasticity of demand and supply.

A decision by a monopolist to increase the price of product will force him to want to know the effects on the sales revenue. Elasticity is expressed as percentage and often corresponds to the line slope. This means that the measuring units do not matter but only the slope. Since demand and supply can be curves or simple lines like the slope, it means that elasticity is not equally distributed on the line.

Price elasticity demand = percentage change in quantity demanded divided by percentage change in the price of the goods.

Hence PEoD = (% Change in Quantity Demanded)/ (% Change in Price)

Hence, we must understand the following rules:

* If PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes)

* If PEoD = 1 then Demand is Unit Elastic

* If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

Elasticity is calculated as the quantity change divided by the price change. For instance if the price moves from $ 1 to $2, and the amount supplied rises from 300 to 302 exercise books, the slope will simply be 2/1 or 200 books per dollar. Because elasticity relies on percentages, the quantity of books supplied increased by 2% while the price increased by 10 % hence the price elasticity of supply is 2/10 or 0.2. A change in currency or unit of measurement does not affect elasticity because the changes are percentage. If the quantity supplied or demanded changes more with less change in price then it is said to be elastic and the opposite changes leads to inelasticity. A perfectly inelastic supply or elasticity at zero is represented by a vertical supply curve.

Nature of products affects elasticity demand in the sense that basic commodities are not very sensitive to the price changes because the consumers will just continue buying them regardless of the increase in their prices. Commodities, which are sensitive to change like in the construction sector causes, demand elasticity hence cannot be categorized as the basic commodities. The size of the share in the budget of the consumer is directly proportional to the elastic demand. In this scenario, therefore those people who earn little to sustain their lives do not fall into this category. However, construction falls in here because the amount of shares an individual owns will determine the elasticity of demand for that commodity.

In substitutes and complimentary goods, the responsiveness of the change in the price of a good in relation to the quantity demanded is measured. In complementary goods, consumption of one commodity leads to an automatic consumption of the other commodity. In substitute commodities, the percentage change in the substitute commodity affects the related commodity. A 10% increase for instance in a compliment good like petrol, the number of cars decreases by twenty percent and the price of elasticity of demand will be -2.0.