In this lesson, we’ll discuss elasticity in economics, including its definition, the different types of elasticity, and their effect on the business market. We’ll also use a real-life example and learn how to use simple formulas to calculate elasticity of demand.

Definition of Elasticity

In today’s economy, doesn’t it seem that the less expensive a product, the more people seem to want it? In economics, elasticity is used to determine how changes in product demand and supply relate to changes in consumer income or the producer’s price. To calculate this change, we can use the following formula:

Elasticity = % Change in Quantity / % Change in Price


Elasticity


The diagram here shows the changes in price (p) of Mabel’s Homemade Candy and the corresponding change in the quantity demanded (q). The red slanting line is called the demand curve. At a price of $1.50, the quantity demanded is three units. When the price is lowered to $0.50, the quantity in demand increased to five units. Ms. Mabel can then make the assumption that every increase in price will result in fewer purchases of her candy.

Income Elasticity of Demand

Income elasticity of demand is a measure of the responsiveness of the demand for a particular good or service, as a result of a change in income of the target market or ceteris paribus. Ceteris paribus is a Latin phrase used in economics, meaning ‘with all other factors held constant’. To calculate this change, we use a different formula:

Income Elasticity of Demand = % change in quantity demanded / % change in income

Interpretation

There are three basic ways that the result of an elasticity calculation may be interpreted:

  • Inelastic: The result is less than 1(< 1), meaning that spending is not very price sensitive
  • Unitary Elasticity: The result is equal to 1 (= 1), meaning when spending changes are proportionate with price changes
  • Elastic: The result is greater than 1 (> 1), meaning that spending is fairly price sensitive

Advantages and Disadvantages of Using Elasticity

Among the many advantages of using elasticity to make business and marketing decisions, some include the simplicity of the process, or its usefulness in predicting the effect of price changes on revenue and expenditure. It can also be used to predict how volatile a price is after an unexpected change in supply or the effect of changes in taxation on the quantity of the product demanded. As an economic tool, elasticity can help determine whether the tax costs can be passed on to the customer through a price increase.

Some economists believe that the only disadvantage of using elasticity for decision-making is if the marketer does not know how to interpret and apply the results. However, when using the theory, marketers should consider other factors that may affect the quantity demanded, aside from changes in price. These factors can include changes in income, family circumstances or the external economic environment.

Lesson Summary

The theory of elasticity refers to the responsiveness of supply and demand to changes in price. In economics, elasticity is used to determine how changes in product demand and supply relate to changes in consumer income or the producer’s price. To calculate this change, we can use the following formula:

Elasticity = % Change in Quantity / % Change in Price

Elasticity in Economics Key Terms

Elasticity in Economics
elasticityeconomics
  • Elasticity: determines how change in product supply and demand relates to changes in consumer income or producer’s price
  • Income elasticity of demand: measure of the responsiveness of the demand for a good or service, due to a change in income of the target market
  • Ceteris paribus: Latin phrase used in economics- ‘with all other factors held constant’

Learning Outcomes

Completing this lesson should help you accomplish the following:

  • Define elasticity in economics
  • Describe the types of elasticity
  • Give examples of how to calculate elasticity