Elasticity is a fundamental economic concept that measures how the quantity demanded or supplied of a good or service responds to changes in its price. It reflects the sensitivity of consumers and producers to price fluctuations.
Types of Elasticity
-
Price Elasticity of Demand (PED): The responsiveness of the quantity demanded to a change in price. It is calculated using the formula:
$$ \text{PED} = \frac{\text{% change in quantity demanded}}{\text{% change in price}} $$ -
Price Elasticity of Supply (PES): The responsiveness of the quantity supplied to a change in price. It is calculated using the formula:
$$ \text{PES} = \frac{\text{% change in quantity supplied}}{\text{% change in price}} $$ -
Income Elasticity of Demand (YED): Measures how the quantity demanded of a good responds to changes in consumer income. The formula is:
$$ \text{YED} = \frac{\text{% change in quantity demanded}}{\text{% change in income}} $$ -
Cross Elasticity of Demand (XED): Measures how the quantity demanded of one good responds to changes in the price of another good. The formula is:
$$ \text{XED} = \frac{\text{% change in quantity demanded of Good A}}{\text{% change in price of Good B}} $$
Calculating Elasticity
Formula for Elasticity Calculation
Elasticity is calculated with various specific formulas, all generally expressed as a ratio of percentage changes:
Where:
- \(E\) represents elasticity
- \(\Delta Q\) is the change in quantity
- \(Q\) is the original quantity
- \(\Delta P\) is the change in price
- \(P\) is the original price
Example Calculation
Suppose the price of a cup of coffee increases from $2 to $2.50, and the quantity demanded decreases from 100 cups to 80 cups per day. The price elasticity of demand (PED) would be calculated as follows:
This implies that for a 1% increase in price, the quantity demanded decreases by 0.8%.
Historical Context
The concept of elasticity was introduced by the British economist Alfred Marshall in the late 19th century. This revolutionary idea allowed economists to better understand the dynamics of supply and demand and their impact on the market.
Real-World Applications
Consumer Goods
Elasticity helps businesses understand how a change in the price of their product might impact sales. For example, luxury goods usually have high price elasticity, meaning that an increase in price significantly reduces the quantity demanded.
Public Policy
Governments utilize elasticity to predict the effects of taxation and to make more informed decisions about resource allocation. For instance, inelastic goods, such as gasoline, can bear higher taxes without causing a significant decrease in consumption.
Related Terms
- Inelastic Demand: When the quantity demanded is relatively unresponsive to price changes (PED less than 1).
- Unitary Elasticity: When the percentage change in quantity demanded is exactly equal to the percentage change in price (PED equals 1).
- Elastic Supply: When the quantity supplied is responsive to price changes (PES greater than 1).
FAQs
What does a negative elasticity mean?
How does elasticity affect revenue?
References
- Marshall, Alfred. “Principles of Economics.” 1890.
- Varian, Hal R. “Intermediate Microeconomics: A Modern Approach.” 2014.
Summary
Elasticity in economics provides insight into how sensitive the quantity demanded or supplied of a good or service is to changes in price. By understanding different types of elasticity, businesses, policymakers, and economists can make better decisions that align with market dynamics.
