J1: Elasticities of Demand

2016 TYS 1a

The price of a pair of jeans can be as little as S$20 or as much as S$500

(a) Explain what might cause price elasticity of demand and cross elasticity of demand to be different for different products. [10]

Introduction
The price elasticity of demand (PED) measures the degree of responsiveness of quantity demanded of a good to a change in its own price, ceteris paribus. There are various determinants which affect the value of PED across different products and these include the availability of substitutes, degree of necessity, proportion of income spent on the good and the time period of analysis (under time constraint, 2 factors suffice). Cross elasticity of demand (CED), on the other hand, measures the degree of responsiveness of demand for one good, say product A, to a change in the price of another good, product B, ceteris paribus. CED is essentially affected by how close product B can complement or substitute product A or both are not related.

R11: Factors resulting in the difference in PED for different Products.

Price elasticity of demand conforms to the law of demand, which states that there is a negative relationship between price and quantity demanded. Hence the sign for PED is negative for most goods. Analysis of PED will thus be more about the value and not about the sign.

One of the factors that leads to the difference in PED for different products is the number and closeness of substitutes. The greater the number of substitutes available for a good and the closer the substitutes, the more price elastic the demand for that good is. For instance, students have a wide range of choices for beverages such as bubble tea, coffee, and smoothies. Thus demand for a particular beverage tends to be price elastic. This is because more consumers are likely to switch to these alternatives when the price of the good increases. Conversely, the demand for water is likely to be price inelastic as there is no close substitute for water currently.

Additionally, the number and closeness of substitute goods also depend on the broadness of the definition of the good. The broader the definition, the more price inelastic is the demand as it is harder to find substitutes. For example, smartphones in general tend to have a price inelastic demand as compared to specific brands like iPhones or Samsung Galaxy phones, which probably have a price elastic demand given that there are many other close substitute brands to choose from.

R2:  Factors resulting in the difference in CED for different Products.

Cross elasticity of demand (CED), unlike PED, can be both positive and negative. To determine whether two goods are substitutes or complements, one must consider the sign of CED; positive for substitutes and negative for complements.

For substitutes, cross elasticity of demand (CED) is positive (CED>0). For example, Golden Village and Cathay cinemas offer close substitutes since the product (movie screening) is nearly identical. When the price of tickets at Golden Village increases, the demand for tickets at Cathay is likely to increase as well, resulting in a positive CED. This means a change in the price of Golden Village tickets will cause the demand for Cathay tickets to change in the same direction.

In the case of complements, cross elasticity of demand (CED) is negative (CED<0). Consider the relationship between gaming consoles and video games. A drop in the price of gaming consoles (like the PlayStation) would significantly increase the demand for video games compatible with that console, resulting in a negative CED. This means a change in the price of PlayStation consoles will cause the demand for PlayStation video games to change in the opposite direction.

Optional: Once the sign has been determined, the magnitude or value of CED depends on the closeness or strength of the relationship between the goods. The closer or stronger one good is as a substitute or complement to another, the larger the impact a price change in the first good will have on the demand for the substitute or complement. For example, Golden Village and Cathay cinemas have a high cross elasticity of demand (│CED│>1) because they are close substitutes. In contrast, Golden Village and Netflix are less close substitutes, leading to a lower cross elasticity of demand (0<│CED│<1). For complements, a strong complementary relationship, like that between gaming consoles and video games, will have a high CED value (│CED│>1). Conversely, weak complements, such as printers and specialty paper, would have a lower CED value (0<│CED│<1).

Conclusion

In conclusion, understanding the determinants of PED and CED is crucial for analyzing consumer behavior and market dynamics. The availability of substitutes and the relationship between goods significantly impact their elasticity, influencing both pricing strategies and demand predictions.