Demand is price elastic if a change in price causes a bigger percentage change in demand. It will have a PED of greater than one.
- % change in price 3/27 = 0.111
- % change in Q.D – 30/80 = – 0.375
- In the above example, the PED = -3.37
Goods will tend to be price elastic with the following characteristics:
- Many substitutes. If consumers have many alternatives, demand will be more sensitive to price. For example, if the price of one type of mineral water (Vittel) increases, people can easily switch to other brands.
- Competitive markets. Related to the first point. If markets are very competitive then demand will be more sensitive to price and therefore demand will be more elastic
- High percentage of income. Luxury goods which are a high percentage of income will be more sensitive to price. If the price goes up, less people will be able to afford it.
- Bought frequently. If we bread every day, we may be more sensitive to changes in price.
Examples of elastic demand
- Dairy milk chocolate bar – there are many other types of chocolate bars to choose from. Note – if chocolate in general increased in price, demand would be inelastic, but for particular types of chocolate demand is elastic.
- Ryanir flights to the continent. An increase in the price of flights from London to Paris would encourage people to take the Channel Tunnel. Also, if flights increase people will not be able to afford it and will choose to take their holiday in the UK.
Tax on a good with elastic demand
With elastic demand, a tax will cause only a small rise in price. There will be a big fall in demand. Most of the tax will be borne by the producer. The consumer burden (increase in price) will be quite small.
Perfectly Elastic Demand
If demand is perfectly elastic, it means that at a certain price demand is infinite (A good with a very high elasticity of demand). In other words if a firm increased price by 1%, it would see all its demand evaporate. If demand is perfectly elastic, then demand will be horizontal.
Examples of Perfectly Elastic Demand
Foreign currency exchange. If you are buying foreign currency, it is likely to exhibit the features of perfect competition. A buyer could choose from many different sellers. The product (e.g. dollars) is identical. Perfect information about cheapest would be easy to find.
Therefore, if one firm increased the price of dollars, above market equilibrium – no one would buy from that firm. They would buy from cheaper alternatives.
Similarly if you are buying potatoes from Covent garden, it is easy to check prices. Therefore, if a farmer increases price above the equilibrium demand will fall significantly, meaning demand is very elastic.
Diagram of Perfect Competition
In a perfectly competitive market it is assumed a firm would have a perfectly elastic demand. This is because if they increased the price, the consumers with perfect information would switch to other firms who offer the identical product.
In perfect competition, we say a firm is a price taker. This means it’s demand curve is perfectly elastic, it has to accept the market price.