An Introduction to the Theory of Elasticity

Elasticity is an economic term that measures responsiveness. Specifically, elasticity measures the response of one economic variable to a change in another economic variable. This is an important concept because it helps illuminate the effects of certain actions. Elasticity in economics usually refers to the price elasticity of demand.

Elasticity and Inelasticity

When prices are increased, consumer demand usually decreases. When prices are decreased, consumer demand usually increases. Elasticity measures these changes. If something is elastic, it is highly responsive to changes in another variable. Elastic demand means that the quantity demanded changes when the price is adjusted. If something is inelastic, it is not as responsive to changes in another variable. Inelastic demand means that the quantity demanded does not change as much in response to a price change.

Factors

Several factors affect the price elasticity of demand. If there are substitutes for a good, its demand is more elastic. For example, if the price at one gas station increases, you can substitute that good with gasoline from the station down the street. The time to adjust to price changes also affects elasticity; demand is usually more elastic in the long run, because more people find substitutes over time. The portion of consumer budget allocated to a good also affects its demand elasticity; if a good composes only a small portion of your budget, you may not care if its price increases.

Calculating Elasticity

The price elasticity of demand is a number calculated by dividing the percentage change in price by the percentage change in quantity demanded. When elasticity is less than one, a good is considered inelastic. When elasticity is greater than one, a good is considered elastic. If elasticity is equal to one, a good is considered to have unitary elastic demand.

Examples

Necessities such as heating homes in winter and air travel for business passengers often have inelastic demand; if the price increases, demand does not change much. Goods with more substitutes, such as brands of gasoline or coffee, restaurants and clothing, are generally elastic.

Applications

Businesses use price elasticity of demand to calculate whether it will be profitable for them to raise or lower their prices. If they sell elastic goods, then increasing their prices will likely decrease their sales and therefore revenue. On the other hand, if they sell inelastic goods, they may be able to increase their prices without losing much business, therefore increasing their total revenue. Some businesses use sales and promotions to price their goods differently to consumers with different levels of demand elasticity. For example, airlines may have lower prices or sales for consumers who purchase their tickets in advance, because these consumers likely have greater flexibility with time and more choices of airlines.

References

• University of South Carolina: Elasticity
• Northern Virginia Community College: Elasticity
• Introduction to Economics