How does the breadth of definition of a market affect PED?

The breadth of definition of a market can significantly influence the Price Elasticity of Demand (PED).

The Price Elasticity of Demand (PED) measures the responsiveness of quantity demanded to a change in price. It is influenced by various factors, one of which is the breadth of definition of a market. The broader the market definition, the lower the PED, and vice versa.

To understand this, consider a market defined broadly as 'beverages'. In this market, if the price of a particular brand of soft drink increases, consumers can easily switch to other types of beverages such as tea, coffee, or juice. This means that the demand for that particular brand of soft drink is highly elastic. However, when we consider the entire beverage market, a price increase in one type of beverage (say soft drinks) may not significantly affect the total demand for all beverages. This is because consumers can substitute the more expensive soft drinks with cheaper alternatives within the same broad market. Therefore, the PED for the broadly defined beverage market is relatively inelastic.

On the other hand, if we define the market narrowly, say 'cola-flavoured soft drinks', the PED is likely to be higher. This is because within this narrowly defined market, there are fewer substitutes available. If the price of one brand of cola increases, consumers may not find it easy to switch to other types of soft drinks that do not have the same taste. Therefore, the demand for that particular brand of cola is likely to be more sensitive to price changes, indicating a higher PED.

In conclusion, the breadth of definition of a market plays a crucial role in determining the PED. A broader market definition tends to lower the PED as it implies more available substitutes, while a narrower market definition tends to increase the PED due to fewer substitutes. Understanding this relationship is important for businesses in making pricing decisions and for policymakers in analysing the potential impacts of tax or subsidy policies.