Introduction
The concept of Price Elasticity of Demand measures the degree of responsiveness of quantity demanded of a commodity to a change in its own price, other factors remaining constant. However, this responsiveness is not the same for all commodities or for all situations. For some goods, even a small change in price causes a very large change in quantity demanded (highly elastic demand), while for others even a substantial change in price hardly affects demand (highly inelastic demand).
T.R. Jain and V.K. Ohri emphasise that the price elasticity of demand for any commodity is governed by a number of economic, psychological and technical factors. These factors must be clearly understood if we are to interpret elasticity coefficients correctly and apply them in business decisions, taxation policy and welfare analysis. In this answer, we discuss in detail the major determinants of price elasticity of demand and simultaneously bring out the importance of each factor from the point of view of theory as well as practical policy.
It is the percentage change in quantity demanded divided by the percentage change in price. Factors discussed below do not change the definition of elasticity; they explain why the numerical value of elasticity differs from commodity to commodity and from situation to situation.
1. Nature of the Commodity
One of the most fundamental determinants of price elasticity is the nature of the commodity in relation to human wants. Commodities may broadly be classified as necessities, comforts and luxuries. The more necessary a commodity is to existence or daily living, the more inelastic its demand tends to be. Conversely, goods that are not essential and can be easily dispensed with have relatively elastic demand.
Necessities (such as food grains, common salt, medicines for chronic diseases) have inelastic demand because consumers cannot reduce their consumption beyond a certain minimum level even if the price rises. On the other hand, luxuries (such as high-end cosmetics, expensive watches, luxury cars) are purchased more out of status, comfort or fashion; their consumption can be postponed or reduced considerably when prices rise, making demand relatively elastic.
- Governments decide which goods can bear heavy indirect taxes (usually necessities with low elasticity are taxed cautiously for equity reasons).
- Business firms judge whether they can increase prices without losing much in terms of sales volume.
- Policy makers classify goods into merit/necessity and luxury categories for subsidies and tax concessions.
2. Availability of Substitutes
The availability, closeness and number of substitutes is perhaps the single most important determinant of price elasticity of demand. When close substitutes are available, a small increase in the price of a commodity induces consumers to shift towards its alternatives, leading to a relatively large fall in demand for the original commodity. Hence, demand is relatively elastic.
In contrast, if a commodity has no close substitutes, consumers have very few alternatives to switch to when its price rises. This makes the demand relatively inelastic. For example, the demand for a particular brand of toothpaste is more elastic than the demand for toothpaste as a broad category, because brands within the category can be easily substituted.
- In competitive markets with many close substitutes, firms must keep prices strategically aligned, as demand is highly responsive.
- Substitutes determine the degree of monopoly power: fewer substitutes mean greater control over price with lesser loss of sales.
- Regulators and antitrust authorities study substitutes to define the “relevant market” and assess market power.
3. Goods with Different Uses (Multiple Uses)
Some goods can be put to several different uses. Electricity, water, coal, steel, milk etc. are classic examples of goods having multiple uses such as domestic consumption, industrial use and commercial purposes. When the price of such a commodity falls, consumers extend its use from more essential to less essential purposes. Consequently, quantity demanded increases significantly, making demand more elastic.
When price rises, consumers concentrate consumption only on the most essential uses and reduce or abandon secondary uses, causing a relatively large contraction in quantity demanded. Thus, the more numerous and important the uses of a commodity, the more elastic its demand tends to be with respect to price.
- In commodities with multiple uses, price changes not only affect total demand but also the pattern of allocation across uses (domestic vs industrial).
- Producers and public utilities must consider priority uses when setting prices so that essential applications are protected.
- Elasticity in such cases plays a key role in rationing and allocation policies during scarcity.
4. Postponement of the Use
The possibility of postponing consumption of a commodity greatly influences its price elasticity of demand. If the use of a commodity can be postponed without seriously affecting the consumer (for example, buying a new mobile phone, replacing furniture, going on a holiday), then demand is generally more elastic. When prices are high, consumers can simply delay the purchase and wait for a more favourable price.
Conversely, in the case of goods whose use cannot be postponed (life-saving drugs, staple food items, basic clothing, essential utilities), consumers are forced to buy them immediately irrespective of price changes. The demand for such non-postponable goods tends to be relatively inelastic.
- Producers of durable and semi-durable goods must recognise that their products often face elastic demand because purchases can be timed.
- In inflationary periods, postponable goods tend to experience stronger demand contractions, magnifying cyclical fluctuations.
- Government policy to stimulate demand (e.g., through interest rate cuts) often targets postponable purchases such as housing and vehicles.
5. Income of the Consumer
The level of income of consumers also affects the price elasticity of demand. For high-income groups, a change in the price of many ordinary commodities constitutes a relatively small portion of income and therefore does not greatly influence their consumption decisions. For such consumers, the demand for many commodities is likely to be relatively inelastic.
For low-income consumers, however, even moderate price changes can significantly affect their purchasing power. They are compelled to adjust quantities more sharply when prices rise, making their demand for many goods relatively elastic. In aggregate, income distribution and average income level thus have an important bearing on overall elasticity in a market.
- Elasticity patterns differ across income groups; firms targeting low-income markets must be more cautious with price increases.
- Public policy regarding essential goods must consider that price hikes hurt low-income groups more because their demand is more price responsive.
- Income-sensitive elasticity is central to welfare analysis and to designing targeted subsidies.
6. Habit of the Consumer
The habitual nature of consumption has a strong influence on price elasticity. Goods which form part of a consumer’s habit—such as tea, coffee, cigarettes, pan masala etc.—often exhibit relatively inelastic demand in the short period. Habit makes consumers less sensitive to price changes because they are psychologically attached to the commodity and find it difficult to reduce or stop consumption.
Over the very long run, if prices remain persistently high or if health awareness increases, habits can change and demand may become more elastic. But in the typical short-run context used in elasticity discussions, habit-forming goods show lower price elasticity.
- Habit reduces elasticity and thereby confers some degree of pricing power to producers of such goods.
- From a public health standpoint, knowing that demand for harmful habit-forming goods is inelastic has implications for “sin taxes” and regulation.
- Marketing strategies often aim to create brand habits so that future demand becomes less sensitive to price changes.
7. Proportion of Income Spent on the Commodity
The share of a commodity in the consumer's total income is another important determinant of price elasticity. If consumers spend only a small proportion of their income on a commodity (such as salt, matchboxes, small stationery items), even large changes in its price have a negligible effect on their budget. As a result, demand for such goods tends to be relatively inelastic.
On the other hand, if a commodity accounts for a large proportion of income (such as housing rent, automobiles, higher education, major appliances), then price changes considerably affect the consumer’s budget and force readjustments in quantity demanded. Consequently, demand is more elastic.
- Helps firms and policy makers anticipate reaction to price changes in big-ticket vs small-ticket items.
- Supports the design of progressive consumption taxation: heavy taxes on small budget items are regressive and politically sensitive.
- Affects marketing policy: for high-income-share products, firms often rely on instalment plans and credit facilities to soften the effect of price on demand.
8. Price Level
The existing price level of a commodity also influences its elasticity. At very low prices, even substantial percentage changes in price may not induce large changes in quantity demanded because consumption may already be near saturation. Hence demand may become relatively inelastic at very low price levels.
At moderate or higher price levels, the same absolute change in price may represent a larger percentage change and provoke stronger consumer reaction, giving a higher elasticity. Thus, elasticity is not uniform along the demand curve; it may be higher at some price ranges and lower at others, depending partly on the price level.
- Shows why elasticity is typically higher on the upper portion of a straight-line demand curve and lower on the lower portion.
- Guides firms in deciding at which segment of the demand curve they should operate for revenue or profit maximisation.
- Explains why additional price cuts in already low-priced items may not substantially raise sales volumes.
9. Time (Short Run and Long Run)
The time period available for consumers to adjust to price changes is a classic and very important determinant of elasticity. In the short run, consumers may find it difficult to change their consumption habits, alter durable goods, or find substitutes; hence demand is relatively inelastic.
In the long run, however, consumers have more opportunities to reorganise their consumption: they can search for substitutes, change technology, shift to alternative goods, or adopt new habits. This makes demand more elastic in the long run than in the short run. Thus, elasticity tends to increase with the passage of time.
- Clarifies why immediate reactions to price changes differ from long-run reactions; policy evaluation must consider both horizons.
- Helps firms distinguish between temporary price promotions (short-run) and permanent price changes (long-run elasticity effects).
- Essential for analysing the impact of long-term policies such as energy taxes, where demand becomes more elastic as consumers can upgrade technology.
10. Joint Demand (Complementary Goods)
When two or more goods are consumed together to satisfy a particular want—like car and petrol, printer and cartridges, pen and ink—they are said to be in joint demand. In such cases, the elasticity of demand for one good is influenced by the demand situation and price behaviour of its complements.
If the complementary good is expensive or has elastic demand, the joint demand may become more sensitive to price changes in either good. For example, if petrol prices rise sharply, the demand for cars may also show increased sensitivity, and vice versa. The interdependence among complementary goods makes elasticity analysis of a single good more complex.
- Pricing decisions for goods in joint demand must be taken in a coordinated manner; the elasticity of the “system” matters more than that of one item.
- Taxing a complementary good (e.g., petrol) can indirectly influence demand for related goods (e.g., cars), affecting industries and employment.
- Bundle pricing, tie-in sales and strategic complements are all analysed using elasticity under joint demand conditions.
11. Other Factors (Advertising, Expectations, Fashion etc.)
Apart from the major determinants mentioned above, there are several additional factors that can influence the numerical value of price elasticity of demand:
- Advertising and brand loyalty: Heavy advertising may reduce elasticity by strengthening brand loyalty.
- Consumer expectations: Expectations of future price rises can temporarily make demand less sensitive to current prices, and vice versa.
- Fashion and social prestige: For fashionable or status goods, consumers may continue to buy despite price increases, reducing elasticity.
Overall Importance of Studying Determinants of Elasticity
Knowledge of the factors determining price elasticity of demand is indispensable for:
- Business firms: Correctly anticipating how consumers will react to price changes and designing pricing strategies accordingly.
- Government and policy makers: Formulating tax and subsidy policies, regulating essential goods and evaluating welfare effects.
- Economists and planners: Conducting realistic demand forecasts and analysing the distributional impact of price and income changes.
Conclusion
To conclude, the price elasticity of demand for any commodity is not a fixed or mysterious figure; it is the outcome of a systematic set of determinants—nature of the commodity, availability of substitutes, multiplicity of uses, possibility of postponement, income level, habits, budget share, prevailing price level, time period and joint demand, along with other psychological and institutional factors. A thorough and structured understanding of these determinants enables students to interpret elasticity coefficients meaningfully and equips decision-makers with a powerful tool for sound economic policy and business strategy.