People respond differently to changes in prices for different goods. Suppose, for example, that the price of jam rises: consumers might easily switch to marmalade, leading to a fairly large fall in the demand for jam. Demand for jam is thus sensitive to changes in prices – what economists call elastic demand. In contrast, consider a village only served by a single bus: a rise in the bus fares might not affect demand very much. Here bus travel is said to be price inelastic.
The elasticity of demand is the degree to which demand for a good or service varies with its price. It refers to how sensitive the demand for a good is to changes in other economic variables, such as the prices and consumer income.
The law of demand guides the relationship between price and the quantity bought. It states that the quantity purchased has an inverse relationship with price. When prices rise, people buy less. The elasticity of demand tells you how much the amount bought decreases when the price increases. Demand elasticity is calculated by taking the percent change in the quantity of a good demanded and dividing it by a percent change in another economic variable. A higher demand elasticity for a particular economic variable means that consumers are more responsive to changes in this variable, such as price or income.
Goods that are necessities, or those for which there are few substitutes, tend to be inelastic, while those that are luxuries or are easily substitutable tend to be elastic. In the short term, demand tends to be more inelastic, but over time consumers may adjust to price changes. In the 1970s, the oil-producing countries attempted to keep the price of oil high to earn themselves large revenues. In the long run, however, consumers reduced their demand for oil by switching to more fuel-efficient cars.
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