Elasticity Of Demand

Elasticity Of Demand

Elasticity of demand depends principally upon the availability of substitutes. If at the ruling price a commodity has close substitutes, a change in price will probably affect demand considerably. One brand of butter is on the whole a good substitute for another brand, and an increase in its price, other things being equal, will cause consumers to buy other brands. The percentage fall in the quantity demanded will be larger than the percentage rise in price. If a commodity has no or few close substitutes at the ruling price, the increase in price will result in a less than proportionate decrease in the quantity demanded. Since, in the long run, effective substitutes can be found for most commodities, it follows that the long-run elasticity of demand for most commodities is also likely to be high. (This is an important 'natural' limitation of the power of monopoly sellers to rig the market in their favour.) The proportion of income spent upon a commodity will also affect the elasticity of demand for it. Generally, when a consumer spends only a small proportion of his income on a commodity, he is relatively insensitive to price changes. Even a large increase in the price of drawing pins is not likely to cause much change in the quantity demanded.

The foregoing relates to price-elasticity of demand. Unless qualified, this is the usual interpretation of the term 'elasticity'. The quantity of a commodity demanded responds to other things than price. For example, when incomes change consumers normally redistribute their expenditures. As their incomes rise people will buy more of some goods and less of others. Changes in quantities demanded may therefore usefully be expressed in relation to changes in income as well as to changes in price. The resultant measure is called income elasticity of demand. If demand changes more than proportionately when incomes change, it is said to be income-elastic, and vice versa.

A practical application of the elasticity concept is in relation to commodity taxation. Ignoring other considerations (which in practice may be of equal or more importance) a Chancellor would ideally try to levy taxes on commodities with a low price-elasticity of demand (thus minimizing consumers' shifts to other commodities) and a high income-elasticity of demand (so that commodity tax revenue keeps pace with changes in national income).

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