Demand elasticity measures how sensitive the quantity demanded of a good or service is to changes in other variables. Many factors are important in determining the demand elasticity of a good or service, such as the price level, type of good or service, availability of a substitute and level of consumer income.
The price level affects the demand of a good or service. The price elasticity of demand can be used to measure the sensitivity of a change in the quantity demanded of a good or service relative to a change in its price. The price elasticity of demand is calculated by dividing the percent change in the quantity demanded of a good or service by its percent change in its price level. A change in the price level of a good or service determines the elasticity of the good.
For example, luxury goods have a high elasticity of demand because they are sensitive to price changes. Suppose the prices of LED televisions decrease in price by 50%. The demand increases, because they are more affordable to those who were unable to purchase them before.
The type of good or service also affects the elasticity of demand. A good or service may be a luxury, a necessity or a comfort to a consumer. When a good or service is a luxury or a comfort good, it is highly elastic when compared to a necessary good. A necessary good, such as food, is generally inelastic because consumers still buy food even if the price changes.
The availability of substitute goods affects the demand elasticity of goods or services. Hence, the demand for goods or services with many substitutes is highly elastic. A small increase in the price levels of goods causes consumers to buy its substitutes. When close substitutes are available, the quantity demanded is highly sensitive to changes in the price level and vice versa. The demand elasticity of goods with close substitutes is measured by dividing the percent change of the quantity demanded of one product by the percent change in the price of a substitute product. This formula is also known as the cross elasticity of demand.
For example, demand for soda is highly elastic because of a large number of substitutes. If the price of one soda rises, consumers opt to buy the cheaper substitute.
The level of consumer income plays a role in the demand elasticity of goods and services. The income elasticity of demand is used to measure the sensitivity of a change in the quantity demanded relative to a change in consumers' incomes. Different types of goods are affected by income levels. For example, inferior goods, such as generic products, have a negative income elasticity of demand. The quantity demanded for generic products tends to fall as consumers' incomes increase.