Substitutes, necessity, addiction, brand loyalty, share of income, time and how widely the good is defined, and how to use them in an answer.
In June 2022 Tesco stopped stocking some Heinz products after a row over how much Heinz wanted to raise its prices. Within days the two sides had reached a deal and the products were back. Heinz was betting that shoppers are loyal to its brand. Tesco was betting they would switch to other ketchups and beans.
Who was right depends on the price elasticity of demand for Heinz. What decides it?
Source: BBC News (June and July 2022).
Demand is price elastic when buyers have easy ways to avoid a price rise: switch to something else, go without or wait. It is price inelastic when they do not.
The main factors:
Elastic and inelastic describe a single figure: PED above 1 (ignoring the minus sign) is elastic, below 1 is inelastic.
More elastic and less elastic compare two figures. Demand for petrol might have a PED of −0.1 in the first month and −0.4 after five years. Long-run demand is more elastic, but it is still inelastic, because 0.4 is below 1.
So write “demand becomes more price elastic over time”, not “demand becomes elastic over time”, unless the figure actually passes 1. Most factors tell you whether demand is more or less elastic than for another good, not which side of 1 it is on.
Which would you keep buying if its price doubled?
Your usual toothpaste, or one particular brand of chocolate bar.
For most people, which has the more price elastic demand?
There are plenty of other chocolate bars, and you can easily go without. Toothpaste is a necessity and a small share of your spending. The more ways buyers have to avoid a price rise, the more elastic demand is.
Two goods, both selling 10 at £10. The flat curve is elastic, the steep one inelastic. Each factor tells you which curve a good’s demand looks like.
Substitutes matter most. If one café raises its prices, you go to the café next door: elastic. If all coffee gets dearer, there is less you can do. So the more widely a good is defined, the fewer substitutes it has and the more inelastic its demand.
Check: Why is demand for one brand of petrol more elastic than demand for petrol as a whole?
If one station raises its price, drivers can go to another. If all petrol rises, there is no substitute: the narrower the definition, the more elastic.
Necessities, such as basic food, heating or medicines, are inelastic: you need them whatever the price. Addictive goods and habits, like cigarettes, are inelastic too. So are brands people are loyal to: Heinz was betting on this. And goods that take a tiny share of income, like salt or matches, barely affect your budget, so you hardly notice a price rise.
Now the other side: goods with elastic demand.
Check: Which of these is likely to have the most price elastic demand?
A holiday abroad is a luxury that takes a large share of income, so people can put it off or go without when the price rises.
Luxuries, such as holidays abroad, are elastic: you can go without. Goods that take a big share of income, like a car, are elastic: a 10% rise is a lot of money, so people shop around or wait.
Time. In the short run, buyers cannot change much: they still have to drive to work. Given time, they find substitutes: a more efficient car, an electric car, the bus. So demand becomes more elastic in the long run.
Check: Petrol prices rise and stay high. Compared with the first month, after five years demand for petrol is likely to be:
Over time drivers can change cars, move nearer work or switch to public transport or an electric car: more ways out, so more elastic.
Sometimes the factors point in different directions.
Check: A designer handbag is a luxury and costs a large share of income, but its buyers are very loyal to the brand. What can you say about its PED?
Being a luxury and a big share of income make demand more elastic; brand loyalty makes it less elastic. Which wins can differ between groups of buyers.
In an exam, do not list factors. Pick the one or two that matter most for the good in the question and explain the chain: this good has few close substitutes, so buyers cannot easily switch, so quantity demanded falls proportionately less than price rises.
Being cheap is not the reason. What matters is that bread is a small share of income and a necessity: a price rise is barely noticed and people still need it. One brand of bread, though, has many substitutes and is elastic.
Explain two reasons why demand for cigarettes is likely to be price inelastic.
First, cigarettes are addictive. Smokers find it hard to cut down, so when the price rises they keep buying close to the same amount.
Second, there are few close substitutes for cigarettes, so smokers cannot easily switch to something else when the price rises. (Vapes are now a partial substitute, which may make demand less inelastic than it was.)
For both reasons, quantity demanded falls proportionately less than the price rises, so PED is between 0 and −1: price inelastic. Estimates of around −0.4 support this.
Demand is likely to be more elastic in the long run, as smokers have time to quit, and for young smokers, for whom cigarettes are a bigger share of income.
Tesco and Heinz: BBC News (June 2022). Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed. Your answers are saved only on this device.