Elasticity: Meaning, types, examples and more

The theory of demand and supply influences economic decisions. This article provides an in-depth explanation of elasticity, including its meaning, types, and applications. The work explores the key factors that affect elasticity and how it can be calculated, as well as provide real-world examples to illustrate its importance in decision-making.

What is Elasticity?

Elasticity is a measure of how responsive the quantity demanded or supplied is to changes in one or more variables, such as price or income. Elasticity can also be referred to as an essential concept in economics that measures how responsive demand or supply is to changes in price, income, or other factors. It is a fundamental tool used by businesses, governments, and policymakers to understand the behaviour of consumers and producers in the market.

Types of Elasticity

In economics, there are several types of elasticity that are commonly used to analyze market behaviour:

1. Price Elasticity of Demand (PED)

Price Elasticity of Demand measures the responsiveness of the quantity demanded of a product or service to a change in its price. If the demand for a good is highly responsive to price changes, it is said to be elastic.

On the other hand, if the demand for a good is not very responsive to price changes, it is said to be inelastic.

2. Price Elasticity of Supply (PES)

Price Elasticity of Supply measures the responsiveness of the quantity supplied of a product or service to a change in its price. If the supply of a good is highly responsive to price changes, it is said to be elastic.

On the other hand, if the supply of a good is not very responsive to price changes, it is said to be inelastic.

3. Income Elasticity of Demand (YED)

Income Elasticity of Demand measures the responsiveness of the quantity demanded of a product or service to a change in consumer income. If the demand for a good increases as consumer income increases, it is said to be a normal good.

If the demand for a good decreases as consumer income increases, it is said to be an inferior good.

4. Cross-Price Elasticity of Demand (XED)

Cross-Price Elasticity of Demand measures the responsiveness of the quantity demanded of one product or service to a change in the price of another product or service. If the demand for a product increases when the price of another product increases, the products are said to be substitutes.

If the demand for a product decreases when the price of another product increases, the products are said to be complements.

Factors affecting Elasticity

Several factors can influence the elasticity of demand or supply for a product or service.

1. Availability of substitutes: If there are many substitutes available for a product, consumers are more likely to switch to another product if the price of their preferred product increases, making the demand for the original product more elastic.
2. Time horizon: In the short term, demand for a product or service may be relatively inelastic because consumers may not have enough time to adjust their consumption patterns. However, over time, consumers may be able to find substitutes or change their behaviour, making demand more elastic.
3. Necessity: If a product is a necessity, consumers may be willing to pay a higher price for it, making the demand for the product relatively inelastic.
4. Brand loyalty: If consumers are loyal to a particular brand, they may be less likely to switch to a substitute product if the price of their preferred product increases, making the demand for the original product less elastic.
5. Income level: The elasticity of demand for a product may vary depending on the income level of the consumers. For example, luxury goods may be more elastic for consumers with lower incomes because they may not be able to afford them.

Calculating Elasticity: the importance of measurement

Calculating elasticity is essential for understanding the responsiveness of demand or supply to changes in price, income, or other factors. The formula for calculating elasticity is:

Elasticity = Percentage change in quantity / Percentage change in price or income

For example, if the price of a product increases by 10% and the quantity demanded decreases by 20%, the price elasticity of demand can be calculated as follows:

Price Elasticity of Demand = -20% / 10% = -2

A negative value for elasticity indicates that demand is inversely related to price, meaning that as the price of a product increases, the quantity demanded decreases.

The importance of calculating elasticity lies in its ability to provide valuable information about the behavior of consumers and producers in the market. For example, if the elasticity of demand for a product is high, a small change in price can have a significant impact on the quantity demanded. In this case, a business may need to adjust its pricing strategy to avoid losing customers or to maximize profits.

Real-world examples of Elasticity

Elasticity can be observed in many real-world examples, from the price of gasoline to the cost of healthcare.

One well-known example of price elasticity of demand is gasoline. Gasoline is a necessity for many people, but it is also a product for which there are few substitutes. Therefore, in the short term, the demand for gasoline is relatively inelastic. However, over time, consumers may be able to switch to more fuel-efficient vehicles, carpool, or use public transportation, making the demand for gasoline more elastic.

Another example is the cost of healthcare. Healthcare is a necessity for many people, and the demand for healthcare services is typically inelastic because people are willing to pay a higher price to maintain their health. However, the elasticity of demand for healthcare can vary depending on the type of service. For example, the demand for elective surgeries may be more elastic because consumers may be more likely to delay or forego these services if the price increases.

The cross-price elasticity of demand can also be observed in the market for soft drinks. If the price of one brand of soft drink increases, consumers may switch to a competing brand, making the demand for the original brand less elastic. Similarly, the income elasticity of demand can be observed in the market for luxury goods. If consumer income increases, the demand for luxury goods may increase, making these products more elastic.

Conclusion 

Elasticity is a crucial concept in economics that measures the responsiveness of demand or supply to changes in price, income, or other factors. Understanding elasticity and its different types can help individuals and businesses make informed decisions and promote efficiency in the economy.

Price elasticity of demand measures the responsiveness of demand to changes in price, while income elasticity of demand measures the responsiveness of demand to changes in income.

Elasticity is important in economics because it helps businesses, policymakers, and consumers understand how changes in price, income and other factors can affect the behaviour of consumers and producers in the market and can inform policy decisions related to taxation, subsidies, and other economic interventions.