Question

The price elasticity of demand coefficient for a good will be lower a. if there are few or no substitutes available. b. if a small portion of the budget will be spent on the good. c. in the short run than in the long run. d. if all of the above are true.

Short answer

The price elasticity of demand coefficient for a good will be lower if all of the above conditions (a, b, and c) are true, since each of them contributes to a less sensitive demand and a lower price elasticity of demand coefficient.

Step-by-step solution

Explanation of Price Elasticity of Demand

Price elasticity of demand is a measure of how sensitive the quantity demanded of a good is to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. In other words, it tells us how a change in price of a good will affect the quantity demanded. A lower price elasticity of demand coefficient indicates that the demand for the good is inelastic, meaning it is less sensitive to price changes. A higher price elasticity of demand coefficient means that the demand is elastic, which means it is highly sensitive to price changes. Now, let's analyze each option to determine the correct answer.

Option (a): Few or no substitutes

If there are few or no substitutes available for a good, consumers have limited options when the price of that good changes. As a result, the demand for the good is less sensitive to price changes, making its price elasticity of demand coefficient lower. Therefore, option (a) is correct.

Option (b): Small portion of the budget

If a good represents a small portion of a consumer's budget, the impact of a price change on the consumer's overall budget is small. As a result, consumers are less sensitive to price changes, and the price elasticity of demand coefficient is lower. Thus, option (b) is also correct.

Option (c): Short run vs. long run

In the short run, consumers typically have less flexibility and fewer options, as it may take time to find substitutes for a good when its price changes. Therefore, the demand is less sensitive to price changes in the short run compared to the long run, leading to a lower price elasticity of demand coefficient. Hence, option (c) is correct as well. Given that all the above options independently describe a situation where the price elasticity of demand coefficient is lower, the correct answer is:

Option (d): All of the above

The price elasticity of demand coefficient for a good will be lower if all of the above conditions (a, b, and c) are true, since each of them contributes to a less sensitive demand and a lower price elasticity of demand coefficient.

Key concepts

Substitutes in Market

Understanding the role of substitutes in the market is fundamental when studying the price elasticity of demand. Substitutes are alternative products or services that can fulfill the same need or purpose as another good. When there are more substitutes available, customers can easily switch from one good to another if the price of the former increases. This scenario would result in a higher price elasticity of demand because the quantity demanded of the original good is very sensitive to price changes.

For example, if the price of coffee increases dramatically, and there are several other caffeine sources like tea or energy drinks available, consumers may easily switch to these alternatives. On the other hand, if no substitutes for coffee exist, an increase in price would have a minimal impact on the quantity demanded, depicting inelastic demand. Therefore, the presence of substitutes in the market is directly proportional to the price elasticity of demand.

Consumer Budget Impact

The impact of a consumer's budget on price elasticity of demand reveals how changes in the price of goods can affect consumer purchasing decisions based on the share of their budget allocated to those goods. A good that takes up only a small fraction of the consumer's budget is less likely to be affected by price changes, as the overall financial impact on the consumer is minimal.

Take, for instance, salt. It usually constitutes a tiny portion of household spending. Even a significant percentage increase in the price of salt is unlikely to deter consumers from buying it, as it will have a negligible impact on their overall budget. This results in a low price elasticity of demand for such inexpensive goods. Conversely, goods that consume a more significant portion of the budget, like housing or vehicles, have a higher price elasticity of demand as consumers are more sensitive to price changes due to the more considerable financial impact.

Short Run vs Long Run Elasticity

The distinction between short run and long run elasticity is essential in understanding the temporal aspect of price elasticity of demand. Short run elasticity refers to the immediate reaction in quantity demanded following a price change, while long run elasticity is concerned with the quantity demanded's response over a longer period.

In the short run, consumers are generally limited by current circumstances, such as existing contracts, habits, or lack of knowledge about alternatives. This limits their ability to respond to price changes, leading to a lower price elasticity of demand. Over time, as consumers gradually adjust to price changes by exploring alternatives, altering consumption habits, or innovating new solutions, the demand becomes more elastic. Thus, the long run price elasticity of demand is typically higher than the short run elasticity because consumers have more time and opportunities to adjust to price changes.