Answer
The four determinants of price elasticity of demand are as such:
1. Availability of close substitutes
The greater the availability of close substitutes the greater its elasticity of demand as customers can more freely switch to other goods in response to changes in price.
2. The degree of necessity of the good
The greater the necessity of a good, the more inelastic its demand will be. As a necessity such as food would still be required by the consumer due to its degree of necessity, they are unlikely to respond greatly to changes in price. Likewise, luxuries do not have as great a degree of necessity as compared to necessities and consumers would be able to forgo them if the prices increase beyond their willingness to pay. Luxuries, therefore, have elastic demands.
3. How broadly the market is defined
How broadly the market or good is defined can affect its availability of close substitutes and therefore its elasticity of demand. The broader a market is defined the harder it is to find close substitutes and the more inelastic the demand of the good is.
4. Time Period
The price elasticity of demand of goods tends to be greater over a longer time period. Over time, consumers are able to adjust their consumption habits, behavior and also have more time to find close substitutes, increasing the elasticity of demand of the good.
Work Step by Step
The definitions of the four determinants of price elasticity of demand can be better explained through examples.
1. Availability of close substitutes
Nike sports shoes tend to have more elastic demand as close substitutes are widely available, such as New Balance and Adidas shoes, and consumers can easily switch to them in response to changes in price. A small increase in the price of Nike shoes result in a large decrease in its quantity demanded as consumers switch to buy other brands. On the other hand, eggs do not have a close substitute so the demand for eggs is more price inelastic. A small increase in the price of eggs does not cause a large decrease in the quantity demanded.
2. The degree of necessity of the good
Necessities such as medicine have inelastic demands as increases in price will not greatly reduce people's need for medicine. Luxuries such as yachts are more price elastic and when price increases, there is a large decrease in quantity demanded. The degree of necessity of a good also depends on the preferences of the consumer.
3. How broadly a market is defined
A broadly defined good such as "Shoes" has few close substitutes and have more inelastic demand. Narrowly defined goods such as Nike sports shoes have more close substitutes like New Balance and Adidas sports shoes and thus have more elastic demand.
4. Time period
The price of gasoline can be seen to be more price elastic over time as consumers can decide to take alternatives form of transportation or switch to electric cars. With greater availability of substitutes, its demand thus becomes more elastic.
