As an example, if a 2% increase in price resulted in a 1% decrease in quantity demanded, the price elasticity of demand would be equal to approximately 0.5. It is not exactly 0.5 because of the specific definition for elasticity uses the average of the initial and final values when calculating percentage change. When the elasticity is calculated over a certain arc or section of the demand curve, it is referred to as the arc elasticity and is defined as the magnitude (absolute value) of the following:
Q2- Q1
…………………
(Q1+Q2) / 2
……………………………….
P2 - P1
……………………..
(P1+P2) / 2
where
Q1 = Initial quantity
Q2 = Final quantity
P1 = Initial price
P2 = Final price
The average values for quantity and price are used so that the elasticity will be the same whether calculated going from lower price to higher price or from higher price to lower price. For example, going from $8 to $10 is a 25% increase in price, but going from $10 to $8 is only a 20% decrease in price. This asymmetry is eliminated by using the average price as the basis for the percentage change in both cases.
An elasticity coefficient of 2 shows that consumers respond a great deal to a change in price. If, on the other hand, a 10% change in price causes only a 5% change in sales, the elasticity coefficient will be only 1/2. Economists would say in this case that demand is inelastic. Demand is inelastic whenever the elasticity coefficient is less than one. When it is greater than one, economists say that demand is elastic.
Finally, the price elasticity of demand can be influenced by following factors:
- Availability of substitutes: the greater the number of substitute products, the greater the elasticity.
- Degree of necessity or luxury: luxury products tend to have greater elasticity than necessities. Some products that initially have a low degree of necessity are habit forming and can become "necessities" to some consumers.
- Proportion of income required by the item: products requiring a larger portion of the consumer's income tend to have greater elasticity.
- Time period considered: elasticity tends to be greater over the long run because consumers have more time to adjust their behavior to price changes.
- Permanent or temporary price change: a one-day sale will result in a different response than a permanent price decrease of the same magnitude.
- Price points: decreasing the price from $2.00 to $1.99 may result in greater increase in quantity demanded than decreasing it from $1.99 to $1.98.
Now to better understand the price elasticity of demand that the demand of health care market is a good example.
Individuals make choices about medical care. They decide when to visit a doctor when they feel sick, whether to go ahead with an operation, whether to immunize their children, and how often to have checkups. The process of making such decisions can be complicated, because it may involve accumulating advice from friends, physicians, and others, weighing potential risks and benefits, and foregoing other types of consumption that could be financed with the resources used to purchase medical care. This chapter presents some simple tools for describing these choices and making empirical estimates of the effects of certain factors, such as prices, incomes, and health status.
Despite a wide variety of empirical methods and data sources, the demand for health care is consistently found to be price inelastic.
Although the range of price elasticity estimates is relatively wide, it tends to center on –0.17, meaning that a 1 percent increase in the price of health care will lead to a 0.17 percent reduction in health care expenditures. The price-induced changes in demand for health care can in large part be attributed to changes in the probability of accessing any care rather than to changes in the number of visits once care has been accessed. In addition, the studies consistently find lower levels of demand elasticity at lower levels of cost-sharing.
The demand for health is also found to be income inelastic. The estimates of income elasticity of demand are in the range of 0 to 0.2. The positive sign of the elasticity measure indicates that as income increases, the demand for health care services also increases. The magnitude of the elasticity, however, suggests that the demand response is relatively small. Studies based on long time series data tend to report higher income elasticities. The difference in estimates across time frames is due to the incorporation of the effects of changes in medical technology in studies that use long time series of data.
Although the price elasticity of demand for medical care in general is relatively low, certain types of care are found to be somewhat more price sensitive. Preventive care and pharmacy benefits are among those medical services with larger price elasticities. The finding that the demand for preventive care is more price sensitive than the demand for other types of care is not surprising. The number of available substitutes for a product is a major determinant of demand elasticity. In the case of preventive care, a number of goods and services could possibly serve as substitutes. As a result, when the price of care increases, consumers are able to substitute away from preventive care toward other goods and services that promote health such as nutritional supplements and healthy foods. In addition, preventive medical services may be seen more as a luxury than a necessity and, thus, may be put off when the price of such care increases. Further, the opportunity cost of obtaining preventive care is much higher than it is when the patient is sick, particularly if the illness keeps the individual out of work. It is also likely, that since the benefits of preventive care accrue in the long-term, they are heavily discounted.
To conclude this essay that the elasticity of demand is a measure of the responsiveness of product demand to changes in one of its determinants. The demand determinants for which elasticity measures are typically computed are the price of the good or service, the income of the consumer, and the prices of related goods or services. Elasticity measures are particularly useful because they focus on the relative magnitudes of changes rather than the absolute. As such, elasticity measures are free of units of measurement. This characteristic makes them particularly useful for comparing demand responses across products, countries, and individuals. Also in this essay, in order to better understand the price elasticity of demand, the health care market has been made as a example in discussed ether it is a inelasticity of elasticity.
References:
G. J. (1988), “Health status and the demand for health,” Journal
of Health Economics 7:151–163.
Cook, M. & Farquharson, C., (1998), Business Economics, Chapter 6
Hardwick, P., et al, (1999) 5th Ed, An Introduction to Modern Economics, Chapter3
[www.duke.edu/~dbr1/Health/mba_schedule.html]
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20th March 2005
