In a free market economy market forces such as demand and supply are often responsive to

the changes in Price in attaining market equilibrium. Commented [RK1]: Introduction.

Introduction is optional but it is a good way to start an
essay. You can use some common statements that suits the
Demand is the amount of a goods or services that the customers are willing and able to pay context. You can even prepare a list of introduction
for a range of prices over a period of time. statements to refer to.

As per the Law of Demand, ceteris paribus, when there is an increase in price quantity
demanded decreases and vice versa. It means for any change in price there will be
responsiveness from consumer in terms of quantity demanded.

Price elasticity of demand is a measure of responsiveness of quantity demanded when

there is a change in price of the good itself. Commented [RK2]: Definitions
Identify the relevant definitions for the question and define
them. First look in to the question given and underline the
It is usually calculated through the formula below: economic terms. Define them. Sometimes there are related
economic terms which are not mentioned in the question.
Define them also. Here in this example Demand, Law of
PED = Percentage change in quantity demanded of product X ÷ percentage change in price Demand are relevant definitions besides PED which is given
of product in question itself. Also, underline the definitions.

Based on this PED value, the responsiveness of the product is interpreted as very responsive
which is elastic or less responsive which is inelastic.
The responsiveness of different products is different with the changes in price. Various
factors affect this responsiveness. Out of those three main factors that affect PED are the
Availability of Substitutes, the Proportion of Consumer’s Income Spent and Time and
Elasticity.
Commented [RK3]: I am not giving the detailed
interpretation of PED because that is not the question.
Question is about the three determinants of PED.
Commented [RK4]: I am bringing up the concept and
answering the question. Underline the three determinants
to let the examiner see that you answered the question.

Determinant # 1. The Availability of Substitutes:
Of all the factors determining price elasticity of demand the availability of the number and
kinds of substitutes for a commodity is the most important factor. If for a commodity close
substitutes are available, its demand tends to be elastic. If the price of such a commodity
goes up, the people will shift to its close substitutes and as a result the demand for that
commodity will greatly decline.
I am using only 3 determinants which are important and am
comfortable because I know real-life examples for those. So,
choose the ones which you know real life examples and are
familiar with.
Note: you can also use Complementarity between Goods,
the Number of Uses of a Commodity.

The greater the possibility of substitution, the greater the price elasticity of demand for it. If
for a commodity substitutes are not available, people will have to buy it even when its price
rises, and therefore its demand would tend to be inelastic.

For instance, there are two main sharing taxi providers in Hyderabad, India in 2018. One is
Ola Cabs and the other is Uber. They are considered as close substitutes. Passengers often
chose between those two based on the price difference though other factors such as quick
availability matters. Usually these taxi providers charge different prices during different
timings based on their demand and hour of the day. Passengers check the price of both the
taxi providers in their mobile app and chose that offer lesser price for the same distance.
 P2
P1

Q2 Q1

Figure 1: Demand curve of Uber showing Elasticity of Demand

(PED greater than 1 but less than infinity) Commented [RK5]: Diagrams
Usually it is recommended to mention the example

As seen in the diagram 1, D represents the demand for Uber cabs. Initially the price of Uber
cabs is at P1 and the quantity demanded is at Q1. When there is a increase in price in Uber
app compared to ola cabs app which is from P1 to P2. It means the price of Uber is higher,
many consumers would turn to Ola cabs, and as a result, the quantity demanded of Uber
will decline very much moving from Q1 to Q2. This means Uber is losing (Q1-Q2) customers
due to the increase in the price of (P2-P1). On the other hand, if the price of Uber is less
compared to Ola cabs, many consumers will choose Uber instead of Ola Cabs.

Thus, the demand for Uber is elastic. It is the availability of close substitutes that makes the
consumers sensitive to the changes in the price of Uber and this makes the demand for
Uber elastic.

Likewise, currently demand for Shanghai Metro is inelastic because good substitutes for it
are not available. Though Didi taxi is a substitute, it is not a close one.

P2

P1

Q2 Q1

Figure 2: Demand curve of Shanghai Metro showing Inelastic demand

(PED greater than 0, but less than one)

As seen in the diagram 2, D represents the demand of Shanghai Metro Where P1 is the
initial price and Q1 is the quantity demanded at price P1. If the price of Metro rises from P1
to P2, there will be a slight reduction in commuters reducing the quantity from Q1 to Q2
because the fare is expensive than before. Few people chose alternative transportation
reducing the quantity from (Q1-Q2) for the change in price (P2-P1). But overall people
would use the Metro same as before since good substitutes are not available. The demand
for Metro is inelastic.

Determinant # 2. The Proportion of Consumer’s Income Spent:

Another important determinant of the elasticity of demand is how much it accounts for in
consumer’s budget. In other words, the proportion of consumer’s income spent on a
particular commodity also influences the elasticity of demand for it. The greater the
proportion of income spent on a commodity, the greater will be generally its elasticity of
demand, and vice versa.

The demand for common salt, soap, matches and such other goods tends to be highly
inelastic because the households spend only a fraction of their income on each of them.
When the price of such a commodity rises, it will not make much difference in consumers’
budget and therefore they will continue to buy almost the same quantity of that commodity
and, therefore, the demand for them will be inelastic.

On the other hand, demand for Sarees which is womenswear in India tends to be elastic
since households spend a good part of their income on clothing. In 2017, during Diwali
festival in India, Lot of stores gave discounts on sarees. Sales of sarees increased drastically.
If the price of saree falls, it will mean great saving in the budget of many households and
therefore they will tend to increase the quantity demanded of the Saree. On the other hand,
if the price of saree rises many households will not afford to buy as much quantity of sarees
as before, and therefore, the quantity demanded of sarees will fall.

Determinant # 3. Time and Elasticity:

The element of time also influences the elasticity of demand for a commodity. Demand
tends to be more elastic if the time involved is long. This is because consumers can
substitute goods in the long run. In the short run, substitution of one commodity by another
is not so easy. The longer the period of time, the greater is the ease with which both
consumers and businessmen can substitute one commodity for another.

For instance, currently petrol price in Chennai, india is Rs84 much higher compared to
previous year. if the price of Petrol rises as what is happening now in India, it may be
difficult to substitute petrol immediately as they cannot sell their vehicles. But, given
sufficient time, people will move to alternatives such as electric bikes. Likewise, when the
business firms find that the price of a certain material has risen, then it may not be possible
for them to substitute that material by some other relatively cheaper one.

But with the passage of time they can undertake research to find substitute material and
can redesign the product or modify the machinery employed in the production of a
commodity so as to economise in the use of the dearer material. Therefore, given the time,
they can substitute the material whose price has risen. We thus see that demand is
generally more elastic in the long run than in the short run.

Price elasticity is important to firms because it will influence the price they will charge for
various products or services. If a product has an elastic demand, it means that the amount
demanded will change as the price of the product changes. Businesses will need to closely
monitor how the demand for their products change as the price changes. For example, if the
price of milk doubles, it is likely that the demand for milk will drop since it is a product with
an elastic demand.

If a product has an inelastic demand, businesses don’t need to be as sensitive to changes in

price mainly because people will need to have that product or service regardless of its price.
A good example of this would be the cost to visit a doctor. If a person was really sick and in
urgent need of medical care, it is likely that person would pay whatever price was charged
to visit the doctor. A person probably wouldn’t shop around for the best rate. A similar
situation exists with oil. As oil prices rise, people will still buy gasoline because they need to
get from place to place. While they might reduce oil consumption to some degree, people
still have a need for the gasoline and will purchase it.

Knowing the price elasticity of a product or service will impact the price the businesscan
charge for it. It also will allow a business to develop marketing and pricing strategies that
will allow it to potentially maximize its profits and hopefully reduce its risks.

Price elasticity of demand is a measure of change in quantity demanded of a commodity

relative to a change in its price. If the demand is inelastic, an increase in price results in
increased revenue. If the price rise results in decreased revenue, the demand is elastic.

Knowing the price elasticity of demand, a firm can decide on an optimum price level of their
commodity to achieve their revenue targets. Price elasticity information can help them
decide how much price reduction is necessary to increase revenue to a certain target, or
what level of price increase will be optimal (since extra revenue from a price increase may
be wiped out by decreased demand).

The knowledge of price elasticity of demand also helps firms in devising their marketing
strategies and targeting niche segments. An example is high net worth individuals whose
demand for luxury is inelastic and hence hotels advertise suites to them. On the other hand,
budget travelers have an elastic demand and hence are targeted for 'Standard' rooms.

The concept of elasticity of demand plays a crucial role in the pricing decisions of the

business firms and the Government when it regulates prices. The concept of price elasticity

is also important in judging the effect of devaluation or depreciation of a currency on its

export earnings.

It has also a great use in fiscal policy because the Finance Minister has to keep in view the

price elasticity of demand when it considers to impose taxes on various commodities. We

shall explain below the various uses, applications and importance of the elasticity of
demand.

The business firms take into account the price elasticity of demand when they take

decisions regarding pricing of the goods. This is because change in the price of a product will
bring about a change in the quantity demanded depending upon the coefficient of price
elasticity.

This change in quantity demanded as a result of, say a rise in price by a firm, will affect the

total consumer’s expenditure and will therefore, affect the revenue of the firm. If the

demand for a product of the firm happens to be elastic, then any attempt on the part of the
firm to raise the price of its product will bring about a fall in its total revenue.

Thus, instead of gaining from the increase in price, it will lose if the demand for its product

happens to be elastic. On the other hand, if the demand for the product of a firm happens

to be inelastic, then the increase in price by it will raise its total revenue. Therefore, for

fixing a profit-maximising price, the firm cannot ignore the price elasticity of demand for its
product.