What is Elasticity?
In economics, elasticity is a fundamental concept that measures how much the demand or the supply of a product changes in response to certain factors, such as price or income. It tells us how sensitive consumers or producers are to changes.
The Cambridge Dictionary has the following definition of elasticity:
“The ability of something, such as the number of products sold, to change in relation to something else, such as the product’s price.”
There are main two types – price elasticity of demand and price elasticity of supply.
Price elasticity of demand
This type shows us how much demand for something will change with a change in its price.
If a small increase in price triggers a significant decline in demand, we say that the product has high elasticity.
Luxury items such as designer handbags, high-end electronics, and sports cars are in this category, as are goods with many substitutes, such as bottled water, breakfast cereal, and stationery.
Conversely, if a change in price barely changes demand, we say that the product has low elasticity. Essential goods, such as bread, rice, milk, and table salt, are in this category.
Price elasticity of supply
This type measures how much the quantity of a product that producers are willing to supply changes in response to price fluctuations.
Goods that can be produced easily and quickly, such as t-shirts, baked goods, and simple plastic goods, have a high elasticity of supply. Producers can respond rapidly to changes in price.
Elasticity of supply is lower for products that take longer to make. Examples include automobiles, complex electronics like smartphones, and houses.
Income elasticity of demand
Apart from price, elasticity is also related to income, which measures how demand for something changes as consumer income rises or falls.
Necessities, such as bread or rice, tend to have low income elasticity. Luxury items such as Rolex watches, on the other hand, have high elasticity, meaning that demand rises more as income increases.
Cross-price elasticity of demand
This measures how demand for one product changes when the price of another related product changes. Often, with substitute goods, an increase in the price of one product boosts demand for the other. Examples of substitute goods are butter and margarine, tea and coffee, and smartphones and tablets.
Conversely, with complements, such as printers and ink cartridges, an increase in the price of one leads to a drop in demand for the other.
Conclusion
Elasticity helps businesses set prices optimally and forecast demand. It also helps policymakers predict what impact tax rises or cuts might have on product demand.
It can provide valuable insights into market dynamics, influencing pricing strategies, production planning, and policymaking.
Video – What is Price Elasticity?
This educational video, from our sister channel on YouTube – Marketing Business Network, explains what “Price Elasticity” is using simple and easy-to-understand language and examples.