What Factors Influence a Change in Demand Elasticity?

Demand elasticity is the sensitivity of the demand for a good or service due to a change in another factor. Economists measure demand elasticity to determine how consumer behavior and spending patterns are affected when specific factors are considered.

A good that has a high demand elasticity for an economic variable means that consumer demand for that good is more responsive to changes in the variable. Conversely, a good with low demand elasticity means that regardless of changes in an economic variable, consumers don't adjust their spending patterns.

Below are the factors that exert the greatest influence on the demand elasticity of a product or service.

Type of Good

There are three types of goods: necessity, comfort, and luxury goods. Necessities are goods needed for basic living such as food and housing. Comfort goods are goods that make life nicer and happier, such as televisions, organic foods, or gym memberships. Luxury goods provide added enjoyment and can include a sports car, boat, or an expensive watch.

Goods that are a necessity are typically inelastic, meaning that a change in price is unlikely to impact demand. If the price of gasoline rises, for example, the demand doesn't change all that much since people need to use their cars to get to work. Comfort and luxury goods tend to be more elastic because changes in an economic variable might lead to less consumer demand.

It's important to consider a consumer's taste and point of view since one might consider a product a comfort while another might consider it a luxury. For example, most people own a car and need it to get to-and-from work each day; however, some people who can barely afford food or housing might consider a car a luxury.

Price

One factor that can affect the demand elasticity of a good or service is its price level. For example, a change in the price level of a luxury car can cause a substantial change in the quantity demanded. If, for example, a luxury car maker has an inventory surplus of cars, the company might reduce its prices to increase demand. If the price is reduced far enough, the car might be affordable to consumers that couldn't afford the luxury car's original price.

Of course, the extent of the price change can determine whether or not demand for the good changes and if so, by how much.

Income

Also known as the income effect, the income level of a population also influences the demand elasticity of goods and services. For example, suppose an economy is facing an economic downturn where many workers have been laid off. The decline in annual incomes for the majority of the population might cause luxury items to become more elastic. In other words, a recession might cause people to save their money rather than splurge on luxury items such as flat-screen televisions or expensive watches.

Substitute Availability

If there is a readily available substitute for a good, the substitute makes the demand for the good elastic. In other words, the alternative product makes the demand for a good or service sensitive to price changes. For example, let's say the price of Florida oranges increased due to inclement weather or a bad crop. If California oranges are a close substitute in quality and price, consumer demand for them will rise.

The Bottom Line

Demand elasticity refers to the change in demand for a good or service due to a change in another factor. The main types of demand elasticity are price elasticity, income elasticity, and cross-product elasticity. If demand significantly changes, a good or service is known to be elastic, if demand does not significantly change, a good or service is known to be inelastic.

Common factors that change the demand for a good include the type of good, price, substitute goods, and income. Considering these factors help companies set their prices and adjust them over time to ensure that the demand for their products remains healthy and grows.