Forecast with price elasticity of demand

Economics is not an absolute science. Unlike more empirical fields such as physics or chemistry, economics must consider many human qualities and behaviors, which are sometimes quite unquantifiable. Therefore, economists must do their best to predict the probability of an event based on given data at a specific time.

An example of this behavioral prediction that economists have tried is the price elasticity of demand. The price elasticity of demand attempts to determine the percentage change in the quantity demanded for a particular good or service when the price of that particular good or service changes by a certain percentage.

Key points

  • The price elasticity of demand attempts to determine the percentage change in the quantity demanded for a particular good or service when the price of that particular good or service changes by a certain percentage.
  • When a commodity or service is considered to have fully elastic demand, the change in price will eliminate all demand for that product.
  • Relatively elastic demand means that the change in the quantity of demand for a good or service will be greater than the change in the price of that good or service.
  • Completely inelastic demand means that the demand for goods or services remains the same regardless of the price.
  • Relatively inelastic demand means that the price change of a good or service is greater than the demand for that good or service.

For example, if you are buying a ticket to New York City, you may find that there are 20 flights from your town to New York City, and all flights are the same price except for one. Compared with industry competitors, Bumpy Ride Airlines’ flight charges are $30 higher. Everything about these 20 flights is the same: the same in-flight meals, the same departure and arrival times, and free baggage check-in. The management of Bumpy Ride hopes to test the competitive landscape of the aviation industry and assess what impact they will have on their business if they increase the price of all flights to New York City by $30. How many people are willing to pay an extra $30 to book a flight to New York City through Bumpy Ride?

Most reasonable people will not decide to pay more for a Bumpy Ride flight. Taking into account the diversity of airlines to choose from and the same value proposition, in this case, it is said that demand is completely elastic: Bumpy Ride’s air ticket demand will drop to zero as the price increases. Economists call this fully elastic demand. The figure below illustrates the fully elastic demand.

Fully elastic demand

Fully flexible demand.

Relatively elastic demand

Relatively elastic demand means that the demand for goods or services will be affected by changes in the prices of the goods or services. Generally, when there are many substitutes for the product, the product or service is said to have high price elasticity.

For example, when you walk down the aisle of a grocery store, you may notice pure sugar as well as many other sugar substitutes. If the price of pure sugar rises by $2 per bag tomorrow, would you pay an extra $2 for a bag of sugar when they are sugar substitutes? Most people will shift their preference from pure sugar to sugar substitutes, thereby reducing their demand for pure sugar.

Most economists would agree, and therefore believe that sugar is a highly elastic commodity. The chart below illustrates that the demand for sugar has decreased significantly as prices have risen.

Relatively flexible demand.

Please note that the demand for sugar decreases as the price rises. The sharp drop in sugar demand shows that sugar demand is relatively price elastic. The change in demand is greater than the change in price on a relative basis.

Completely inelastic demand

In theory, completely inelastic demand means that the demand for goods or services remains the same regardless of the price. Think about it; are there any goods or services you are willing to pay for?

Most people who are terminally ill will pay for any known cure for the disease. Most people are willing to pay any price for water. However, the price elasticity of bottled water is relatively large because the supply of tap water is abundant and almost free. The figure below illustrates a completely inelastic demand.

Completely inelastic demand.

Relatively inelastic demand

An example of a commodity that is considered relatively inelastic in price is gasoline. Both businesses and consumers need natural gas to thrive in this economy. Although they are turning to alternative fuels, many people who rely on gasoline in their daily lives cannot and cannot switch to alternative fuels as actual substitutes.

If the price of gasoline goes up by 30% tomorrow, won’t you go to work? Most people will pay a higher price out of necessity. of course there are exceptions. During the oil and gas bubble in 2008, when prices soared to a national average of about $4.10 per gallon, people changed their behavior by reducing gasoline demand. Some economists believe that this shift in demand led to a severe recession in late 2008 and 2009. In the normal market, natural gas is a relatively inelastic product, as shown in the figure below.

Relatively inelastic demand.

Natural gas prices are highly inelastic. Although prices have risen, demand remains relatively stable. Calculated as a percentage, the decrease in demand is less than the increase in prices.

in conclusion

The price elasticity of demand is a way economists try to measure the sensitivity of demand caused by changes in the price of a given product. This measurement can be used to predict consumer behavior and predict major events, such as economic recession or recovery. As consumers, we make decisions that economists measure every day. If the price of a commodity rises and we can do without it, or there are many alternatives, then we will reduce its consumption, or not consume it at all. Water, medicine, and gasoline are necessities, and despite rising prices, we will still have a lot of demand.

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