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Elasticity is an economic concept used to measure how sensitive supply and demand are to changes in price. A very elastic product would see small changes in price result in large changes in demand or supply. The elasticity curve of an individual or society may change for any number or reasons. Changes in taste, preferences, substitutes, or how much someone needs something can alter the elasticity demanded of a good.
The elasticity of demand refers to how responsive the quantity demanded is to changes in the price of a good. To formula to calculate the elasticity of demand is as follows:
Where △Q is the change in quantity demanded. Q represents the average of the two quantities demanded. △P is the change in price and P is the average price.
Example: Suppose the price of a dozen eggs rises from $2 to $2.50. Quantity demanded falls from 20 to 15.
The elasticity of demand for a dozen eggs is 1. So a 5% increase in price will result in a 5% decrease in quantity demanded (5×1=5). Note, in most instances the answer will come up as a negative number but you always take its absolute value.
The elasticity of supply refers to how responsive producers are to changes in price. To calculate the elasticity of supply, simply substitute quantity demanded with the quantity supplied.
Types of elasticity
- Perfectly elastic: =∞ A situation in which quantity drops to 0. People immediately stop buying.
- Elastic: >1 Relatively high elasticity, consumers have plenty of options to substitute out.
- Unit elastic: =1 Equivalent or proportional responsiveness to changes in price.
- Inelastic: <1 A fairly low level of elasticity. People have a difficult time giving up the item and few options.
- Perfectly inelastic: =0 A situation in which there is no change in quantity at all when price changes. People cannot stop buying the item.
Elasticity is a key concept in economics. It is useful for businesses to understand how changes in the prices of their products can impact sales. Elasticity is also used in tax analysis. The more elastic a good is, the more of the incidence of a sales or excise tax will fall on the producer. Conversely, something with an inelastic demand curve will see that most of the tax incidence will fall on the consumer.
- "Price elasticity of demand and price elasticity of supply". Khan Academy. Retrieved 2020-01-26.
- Kenton, Will. "Price Elasticity of Demand". Investopedia. Retrieved 2020-01-26.
- Tax incidence EconomicsOnline.