What is the difference between price elasticity of demand and elasticity of substitution? Explain the various measures of price elasticity of demand.
Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in relation to its price change. Expressed mathematically, it is:
Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price
If the quantity demanded of a product exhibits a large change in response to its price change, it is termed "elastic," that is, quantity stretched far from its prior point. If the quantity purchased has a small change in response to its price, it is termed "inelastic"; quantity didn't stretch much from its prior point.
The more easily a shopper can substitute one product with a rising price for another, the more the price will fall – be "elastic."
The more discretionary a purchase, the more quantity will fall in response to price rises – the higher the elasticity. The less discretionary, the less quantity will fall. Inelastic examples include luxuries where shoppers "pay for the privilege" of buying a brand name, addictive products and required add-on products. Addictive products include tobacco and alcohol. Sin taxes on these products are possible because the lost tax revenue from fewer units sold is exceeded by the higher taxes on units still sold. Examples of add-on products are ink-jet printer cartridges or college textbooks.
Time matters. Response is different for a one-day sale than for a price change over a season or year. Clarity in time sensitivity is vital to setting better online shopping prices.
If the quantity purchased changes more than price change (say, 10%/5%), the product is termed elastic.
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