Chapter 4: Price Elasticity of Demand (PED)
Part 4.2 – Determinants of Price Elasticity of Demand
By Dr. Anthony Fok
Introduction
One of the most common examination questions is not simply asking students to define Price Elasticity of Demand (PED), but to explain why one product has a higher or lower PED than another.
Many students memorise a list of determinants without understanding the underlying economic reasoning.
This often leads to superficial answers that score only average marks.
To achieve an A grade, you should not merely identify a determinant—you must explain how it influences consumers’ responsiveness to price changes and, where appropriate, support your explanation with relevant examples.
What Determines Price Elasticity of Demand?
Several factors influence how consumers react to changes in price.
The most important determinants are:
- Availability of substitutes
- Necessity versus luxury
- Proportion of income spent
- Time period
- Habit-forming or addictive nature
- Brand loyalty
- Definition of the market
Each determinant influences consumer behaviour differently.
1. Availability of Close Substitutes
This is generally regarded as the most important determinant of PED.
The greater the number of close substitutes available, the more elastic demand tends to be.
When prices rise, consumers can easily switch to alternative products.
Example: Coffee Shops
Suppose one neighbourhood café increases the price of a cup of coffee from S$2.00 to S$2.80.
If several nearby cafés sell similar coffee at lower prices, many customers will simply switch.
Demand for that café’s coffee is therefore relatively elastic.
Singapore Example
Ride-hailing services provide an excellent illustration.
If the fare for one platform increases while competing platforms maintain similar prices, commuters can often compare prices within seconds and choose the cheaper option.
The availability of substitutes increases price sensitivity.
Examination Tip
Always explain the switching behaviour.
Do not simply write:
“There are many substitutes.”
Instead explain:
“Consumers can easily switch to alternative products, causing quantity demanded to fall significantly following a price increase.”
That explanation earns considerably more marks.
2. Necessities Versus Luxuries
Necessities generally have relatively inelastic demand.
Luxury goods usually have more elastic demand.
Why?
Consumers find it difficult to reduce purchases of necessities even when prices increase.
Luxury purchases can often be postponed or cancelled.
Necessities
Examples include:
- basic food,
- electricity,
- water,
- essential medicines.
Even if prices increase, households still require these goods.
Demand therefore changes relatively little.
Luxuries
Examples include:
- overseas holidays,
- designer handbags,
- premium watches,
- expensive restaurant dining.
Consumers can delay or reduce these purchases if prices rise.
Demand is therefore more elastic.
Important Evaluation
Not every luxury good has highly elastic demand.
Prestige brands such as Hermès or Ferrari may retain strong demand because exclusivity, status and brand image influence purchasing decisions.
Always analyse the specific market rather than relying on broad generalisations.
3. Proportion of Income Spent
The larger the proportion of income spent on a product, the more responsive consumers usually become to price changes.
Small Proportion of Income
Consider table salt.
Even if the price doubles, most households spend very little on salt.
Many consumers continue buying similar quantities.
Demand is relatively inelastic.
Large Proportion of Income
Now consider purchasing a condominium.
A small percentage increase in price may represent tens of thousands of dollars.
Consumers are much more likely to delay their purchase, negotiate or consider alternatives.
Demand is therefore more elastic.
Singapore Example
Residential property provides a useful illustration.
Because housing represents a substantial financial commitment, buyers typically compare prices carefully and may postpone purchases if prices rise significantly.
4. Time Period
Elasticity often changes over time.
In the short run, consumers may have limited alternatives.
In the long run, they have more opportunities to adjust their behaviour.
Short Run
Suppose petrol prices increase sharply today.
Most motorists still need to drive to work tomorrow.
Demand remains relatively inelastic.
Long Run
Over several years, consumers may:
- purchase electric vehicles,
- relocate closer to work,
- use public transport more frequently,
- carpool.
Demand becomes more elastic because more adjustment options become available.
Examination Tip
Whenever discussing elasticity, consider both the short run and the long run.
This naturally strengthens evaluation.
5. Habit-Forming and Addictive Goods
Products associated with addiction often exhibit relatively inelastic demand.
Examples include:
- cigarettes,
- alcohol,
- gambling services.
Consumers may continue purchasing despite higher prices because addiction reduces responsiveness.
Singapore Example
Governments frequently impose high excise duties on cigarettes.
Although consumption may decline, it often falls by proportionately less than the price increase because demand is relatively inelastic.
This is one reason why taxes on tobacco can generate substantial government revenue while also discouraging smoking.
6. Brand Loyalty
Strong brand loyalty reduces consumers’ willingness to switch to competitors.
As a result, demand becomes more inelastic.
Examples include:
- Apple,
- Tesla,
- Nike,
- Starbucks.
Many loyal customers continue purchasing despite moderate price increases because they perceive the products to be superior or identify strongly with the brand.
However, brand loyalty is not absolute.
Excessive price increases may eventually encourage consumers to consider alternatives.
7. Definition of the Market
The broader the market definition, the more inelastic demand tends to be.
The narrower the market definition, the more elastic demand tends to be.
Broad Market
“Beverages”
Consumers have fewer broad substitutes because almost everyone consumes drinks of some kind.
Demand is relatively inelastic.
Narrow Market
“Sparkling mineral water from a particular brand”
Many close substitutes exist.
Consumers can easily switch.
Demand becomes more elastic.
Summary of the Determinants
| Determinant | More Elastic When… | More Inelastic When… |
|---|---|---|
| Substitutes | Many close substitutes | Few or no substitutes |
| Nature of good | Luxury | Necessity |
| Share of income | Large | Small |
| Time | Long run | Short run |
| Addiction | Low | High |
| Brand loyalty | Weak | Strong |
| Market definition | Narrow | Broad |
Rather than memorising this table, understand the economic logic behind each determinant.
Singapore Case Study: ERP Charges
Electronic Road Pricing (ERP) provides an interesting example.
For some commuters travelling during peak hours, demand is relatively inelastic because:
- work schedules are fixed,
- alternative routes are limited,
- public transport may not always be convenient.
However, for discretionary trips such as shopping or leisure, motorists may choose different travel times to avoid ERP charges.
Consequently, elasticity may vary depending on the purpose of the journey.
This demonstrates that elasticity is influenced by circumstances rather than by the product alone.
Dr. Anthony Fok’s Exam Tip
Students often lose marks by listing determinants without explanation.
For every determinant, train yourself to use the following structure:
- Identify the determinant.
- Explain how consumer behaviour changes.
- State whether demand becomes more elastic or more inelastic.
- Support your answer with an example.
- Where appropriate, evaluate by considering exceptions or different time periods.
This approach produces clear, analytical answers that examiners reward.
Common Student Mistake
❌ “Necessities always have perfectly inelastic demand.”
Incorrect.
Most necessities are relatively inelastic, not perfectly inelastic.
Consumers may still reduce consumption to some extent when prices increase, especially over longer periods.
Always distinguish between “inelastic” and “perfectly inelastic.”
Quick Revision Checklist
By the end of this section, you should be able to:
- Explain all seven determinants of PED.
- Apply each determinant to real-world examples.
- Evaluate how elasticity may differ in the short run and long run.
- Distinguish between broad and narrow market definitions.
- Use Singapore examples to strengthen examination answers.
Understanding these determinants is essential before analysing the relationship between elasticity and total revenue.
Coming Up in Part 4.3
The next section will cover one of the most frequently tested applications of PED:
- Total Revenue (TR)
- PED and business pricing strategies
- Why airlines use dynamic pricing
- Why luxury brands rarely discount
- Why supermarkets hold promotions
- Government taxation and PED
- Cambridge examination questions and model answers