There are three main factors that influence a demand’s price
elasticity:
1. The availability of substitutes
This is probably the most important factor influencing the
elasticity of a good or service. In general, the more substitutes, the more
elastic the demand will be.
For example, if the price of a cup of coffee went up by
$0.25, consumers could replace their morning caffeine with a cup of tea. This
means that coffee is an elastic good because a raise in price will cause a
large decrease in demand as consumers start buying more tea instead of
coffee.
However, if the price of caffeine were to go up as a whole,
we would probably see little change in the consumption of coffee or tea because
there are few substitutes for caffeine. Most people are not willing to give up
their morning cup of caffeine no matter what the price. We would, therefore,
say that caffeine is an inelastic product because of its lack of
substitutes.
Thus, while a product within an industry is elastic due to
the availability of substitutes, the industry itself tends to be inelastic.
Usually, unique goods such as diamonds are inelastic because they have few - if
any - substitutes.
2. Amount of income available to spend on the good
This factor affecting demand elasticity refers to the total
a person can spend on a particular good or service. Thus, if the price of a can
of Coke goes up from $0.50 to $1 and income stays the same, the income that is
available to spend on Coke, which is $2, is now enough for only two rather than
four cans of Coke. In other words, the consumer is forced to reduce his or her
demand of Coke.
Thus if there is an increase in price and no change in the
amount of income available to spend on the good, there will be an elastic
reaction in demand, that is, demand will be sensitive to a change in price if
there is no change in income.
3. Time
The third influential factor is time. If the price of
cigarettes goes up $2 per pack, a smoker, with very little available
substitutes, will most likely continue buying his or her daily cigarettes. This
means that tobacco is inelastic because the change in the quantity demand will
have been minor with a change in price. However, if that smoker finds that he
or she cannot afford to spend the extra $2 per day and begins to kick the habit
over a period of time, the price elasticity of cigarettes for that consumer
becomes elastic in the long run.