# Methods of estimating price-elasticity of demand

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Author: ANACOM
Title: "Methods of estimating price-elasticity of demand"
Published: 21.03.2012
URL: http://www.anacom.pt/render.jsp?contentId=1123854
View: 19.06.2013

The price-elasticity of demand can be defined as a change in the quantity of a product or service consumed/demanded, following a change in the corresponding price (Marshall, 1890). As a rule 1, increases in the price of a product or service tend to result in reduced consumption, while price decreases tend to be followed by increases in consumption (of course, within certain limits, including, in particular, related to diminishing marginal utility of consumption and/or related to time available for consumption).

Generally the price elasticity of demand is classified according to the following levels:

a) Relatively elastic demand - where the percentage change in quantity consumed exceeds the percentage change in price;

b) Unitary elastic demand - where the percentage change in quantity consumed equals the percentage change in price;

c) Relatively inelastic demand - where the percentage change in quantity consumed is less than the percentage change in price;

d) Perfectly elastic demand - when the percentage change in the quantity consumed far exceeds the percentage change in price;

e) Perfectly inelastic demand - where the percentage change in the quantity consumed remains constant, not reacting to the percentage change in price;

Several factors may contribute to affect the intensity of price-demand elasticity, including:

a) The existence of substitute products - for example, when analyzing the price-elasticity of demand for the fixed telephone service (FTS), it is useful to examine the extent to which the FTS is a substitute of the mobile telephone service (MTS);

b) Disposable household income - a lower price of the product and frequency of consumption, relative to disposable income, should reduce the intensity of price elasticity of demand;

c) The necessity of the consumption - for example, if FTS access is seen as absolutely essential by retirees and pensioners who need to be in more frequent contact with health care services in emergency situations, it is possible that demand from this group of customer will tend to be inelastic;

d) Inertia of change - for example, consumers in more advanced age groups are typically more conservative in their preferences and have greater inertia in response to price changes, although in the case of retirees and pensioners with a low level of disposable income, budgetary constraints may counteract this inertia.

Generally, and without going into detail (in this irrelevant context) on the various possible methodological approaches for estimating the price-elasticity of demand, two methods are commonly recognized as providing an estimate of this elasticity, one using historical data on actual consumption for a particular product or service and the other supported by survey data.

In the cited determination of 09.06.2011 and given the clear lack of information that could be used to provide the estimate of elasticity according to the methods commonly used, ICP-ANACOM presented another approach, estimating elasticity using "benchmarking", i.e. using values reported in scientific papers and other documents.

1 Except under conditions characteristic of certain "anomalies". For example, the "Veblen" effect is related to certain "high-status" goods, which become more sought after when the price increases, such as luxury cars and designer clothing. At the opposite extreme, the "Giffen" effect, explains that when certain goods constituting predominant staple consumption by poorer people - e.g. bread - increase in price, poor consumers no longer have money available to eat meat, so that they start eating more bread, even though the price of bread has increased.

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