Handout 5: Elasticity (Work in Progress)

Some more advanced issues relating to elasticity

Before we tackle these advanced issues such as the relationship of elasticity of demand and total revenue, it may be useful to briefly discuss the factors determining the elasticity of demand for consumer goods:

1. The availability of substitute products. The more and better the substitutes the greater the elasticity of demand. If the price goes up more people would switch therefore the demand will drop faster (which is why the curve will be "flatter") in a perfectly comparable situation where there is no substitutes the elasticity is greater. In this case the consumer has no choice but to stay with the product even though the prices have increased substantially (represented by a "steep" or relative inelastic curve that could be approacing zero where there is no availability of a substitute product such as a hear for a heart transplant - irrespective the price, the purchaser would pay almost any price because there is only one that matches - no substitutes).

2. the occurence of compliments. Complements are products that go tegether well in the satisfaction of wants. Some examples are motor vehicles and petrol, cereal and milk, computers and peripheral devices, gas and gas heaters. Here the effect is the opposite. Since the product is used with others an increase in the price of one will lead to a decrease in the the demand of the other. If gas prices would treble there will be a decrease in the the demand for heaters. How drastic the fall would be will be dependent on the cross-elasticity of demand.