Elasticity in economics dates back to the 19th century when the concept was first introduced by Alfred Marshall in his book “Principles of Economics” published in 1890. Marshall’s work laid the foundation for understanding how quantity demanded or supplied responds to changes in price, which has since become a fundamental concept in economics.
Types and Categories of Elasticity
Elasticity can be categorized mainly into the following types:
1. Price Elasticity of Demand (PED)
Definition: Measures the responsiveness of the quantity demanded of a good to a change in its price. Formula:
Interpretation: If the absolute value of PED is greater than 1, the demand is considered elastic.
2. Price Elasticity of Supply (PES)
Definition: Measures the responsiveness of the quantity supplied of a good to a change in its price. Formula:
Interpretation: If PES is greater than 1, the supply is considered elastic.
3. Income Elasticity of Demand (YED)
Definition: Measures the responsiveness of the quantity demanded to a change in consumer income. Formula:
4. Cross Elasticity of Demand (XED)
Definition: Measures the responsiveness of the quantity demanded for a good to a change in the price of another good. Formula:
Key Events
- 1890: Alfred Marshall introduces the concept of elasticity in economics.
- 1951: John Hicks’ “Elasticity of Substitution” theory enhances the understanding of elasticities in production.
Detailed Explanations
Price Elasticity of Demand (PED)
When demand is price-elastic, consumers are highly responsive to price changes. For instance, luxury goods often have high elasticity because a slight increase in price may lead to a significant drop in quantity demanded.
graph TD;
A[High Price] -->|High Elasticity| B[Large Drop in Quantity Demanded]
C[Low Price] -->|High Elasticity| D[Large Increase in Quantity Demanded]
Price Elasticity of Supply (PES)
In the case of supply elasticity, producers can easily alter production in response to price changes. For example, a bumper crop can dramatically increase the supply of a food commodity with a minor rise in market price.
graph TD;
E[High Price] -->|High Elasticity| F[Large Increase in Quantity Supplied]
G[Low Price] -->|High Elasticity| H[Large Decrease in Quantity Supplied]
Importance and Applicability
Elasticity helps businesses and policymakers understand and predict the effects of price changes on the market:
- Pricing Strategies: Businesses use elasticity to set prices that maximize revenue.
- Taxation Policy: Governments consider elasticity to estimate tax impacts on different goods.
- Welfare Analysis: Elasticity informs the assessment of consumer and producer welfare changes due to price adjustments.
Examples
- Cigarettes: Typically inelastic as consumers continue to buy despite price increases.
- Electronics: Often elastic due to availability of substitutes and high competition.
Considerations
- Time Period: Elasticity can vary over the short run and long run.
- Availability of Substitutes: More substitutes usually lead to higher elasticity.
- Necessity vs. Luxury: Necessities tend to be inelastic, while luxuries are elastic.
Related Terms with Definitions
- Inelastic: A variable is inelastic if its elasticity with respect to another variable is less than 1.
- Unitary Elasticity: When elasticity is exactly 1, indicating proportional change in quantity with price.
Comparisons
- Elastic vs Inelastic: Elastic goods see a large change in quantity with price changes, while inelastic goods see little change.
- PED vs PES: PED focuses on consumer reaction, PES focuses on producer response.
Interesting Facts
- Historical Case: The elasticity of salt in the early 20th century was extremely low, showing minimal change in demand despite large price changes.
- Economic Strategies: Price elasticity has been central in determining wartime rationing and subsidies.
Inspirational Stories
A notable example is the introduction of generic medicines. With the entrance of generics, the elasticity of demand for branded drugs increased, leading to lower prices and broader access to medication.
Famous Quotes
- Alfred Marshall: “Elasticity of demand in a market is a measure of how buyers react to changes in price.”
Proverbs and Clichés
- Proverb: “Necessity knows no price.” Reflects the inelasticity of essential goods.
Jargon and Slang
- Price-sensitive: A colloquial term often used to describe goods or services with high elasticity.
FAQs
How do you calculate elasticity?
Why is elasticity important?
Can elasticity be negative?
References
- Marshall, Alfred. “Principles of Economics”. 1890.
- Hicks, John. “Elasticity of Substitution”. 1951.
Final Summary
Elasticity is a crucial concept in economics that measures how one variable responds to changes in another. This responsiveness helps in making informed decisions regarding pricing, taxation, and welfare policies. Understanding the types, implications, and applications of elasticity provides deep insights into market dynamics and consumer behavior.
