Introduction to Elasticity in Economics

Elasticity

A numerical measure of the responsiveness of Quantity Demanded (Qd) or Quantity Supplied (Qs) to one of its determinants.

Price Elasticity of Demand (PED)

Measures how much Qd responds to a change in Price (P), indicating the price-sensitivity of buyers' demand.

Price elasticity of demand formula

Price elasticity of demand = (Percentage change in Qd) / (Percentage change in P)

Midpoint Method

(end value - start value) / midpoint x 100%, where the midpoint is the average of the start and end values.

Availability of Close Substitutes

Price elasticity is higher when close substitutes are available (e.g., breakfast cereal vs. sunscreen).

Necessities vs. Luxuries

Price elasticity is higher for luxuries than for necessities (e.g., Caribbean cruises vs. insulin).

Definition of the Good (Broad vs. Narrow)

Price elasticity is higher for narrowly defined goods than broadly defined ones (e.g., blue jeans vs. clothing).

Time Horizon

Elasticity is higher in the long run than in the short run, as buyers have more time to respond to price changes (e.g., gasoline).

Perfectly Inelastic Demand

Vertical D curve, Elasticity = 0. Quantity demanded does not change with price. Consumers have no price sensitivity.

Inelastic Demand

Relatively steep D curve, Elasticity < 1. Qd changes less than proportionally to P.

Unit Elastic Demand

Intermediate slope D curve, Elasticity = 1. Qd changes proportionally to P.

Elastic Demand

Relatively flat D curve, Elasticity > 1. Qd changes more than proportionally to P.

Perfectly Elastic Demand

Horizontal D curve, Elasticity = infinity. Any quantity can be demanded at a specific price, but at any other price, Qd is zero.

Linear Demand Curve

The slope of a linear demand curve is constant, but its elasticity is not.

Total Revenue

Total Revenue = Price (P) x Quantity (Q).

Revenue Change with Elastic Demand

Revenue Falls when price rises and Revenue Rises when price falls.

Revenue Change with Inelastic Demand

Revenue Rises when price rises and Revenue Falls when price falls.

Price Elasticity of Supply (PES)

Measures how much Qs responds to a change in P.

Formula for Price Elasticity of Supply

Price elasticity of supply = (Percentage change in Qs) / (Percentage change in P).

Rule of Thumb for Supply Curves

The flatter the curve, the bigger the elasticity; the steeper the curve, the smaller the elasticity.

Perfectly Inelastic Supply

Vertical S curve, Elasticity = 0. Quantity supplied does not change with price.

Inelastic Supply

Relatively steep S curve, Elasticity < 1. Qs changes less than proportionally to P.

Unit Elastic Supply

Intermediate slope S curve, Elasticity = 1. Qs changes proportionally to P.

Elastic Supply

Relatively flat S curve, Elasticity > 1. Qs changes more than proportionally to P.

Perfectly Elastic Supply

Horizontal S curve, Elasticity = infinity. Sellers will supply any quantity at a specific price.

Determinants of Supply Elasticity

The more easily sellers can change the quantity they produce, the greater the price elasticity of supply.

Long Run vs Short Run Supply Elasticity

Price elasticity of supply is generally greater in the long run than in the short run.

Income Elasticity of Demand

Measures the response of Qd to a change in consumer income.

Formula for Income Elasticity of Demand

(Percent change in Qd) / (Percent change in income).

Normal Goods

Income elasticity > 0 (demand increases with income).

Inferior Goods

Income elasticity < 0 (demand decreases with income).

Cross-Price Elasticity of Demand

Measures the response of demand for one good to changes in the price of another good.

Formula for Cross-Price Elasticity

(% change in Qd for good 1) / (% change in price of good 2).

Substitutes

Cross-price elasticity > 0 (e.g., increase in price of beef causes increase in demand for chicken).

Complements

Cross-price elasticity < 0 (e.g., increase in price of computers causes decrease in demand for software).

Real-world Examples of Elasticity

Soaring gas costs leading to increased demand for small cars, online courses, bicycles, and even mules.