In economics, elasticity measures the responsiveness of one economic variable to a

change in another.[1] If the price elasticity of the demand of something is -2, a 10%
increase in price causes the quantity demanded to fall by 20%. Elasticity in economics
provides an understanding of changes in the behavior of the buyers and sellers with
price changes. There are two types of elasticity for demand and supply, one
is inelastic demand and supply and other one is elastic demand and supply. [2]

Introduction[edit]
Elasticity is an important concept in neoclassical economic theory, and enables in the
understanding of various economic concepts, such as the incidence of indirect
taxation, marginal concepts relating to the theory of the firm, distribution of wealth, and
different types of goods relating to the theory of consumer choice. An understanding of
elasticity is also important when discussing welfare distribution, in particular consumer
surplus, producer surplus, or government surplus.[3]
Elasticity is present throughout many economic theories, with the concept of elasticity
appearing in several main indicators. These include price elasticity of demand, price
elasticity of supply, income elasticity of demand, elasticity of
substitution between factors of production, cross-price elasticity of demand,
and elasticity of intertemporal substitution.[4]
In differential calculus, elasticity is a tool for measuring the responsiveness of one
variable to changes in another causative variable. Elasticity can be quantified as the
ratio of the percentage change in one variable to the percentage change in another
variable when the latter variable has a causal influence on the former and all other
conditions remain the same. For example, the factors that determine consumers' choice
of goods mentioned in consumer theory include the price of the goods, the consumer's
disposable budget for such goods, and the substitutes of the goods.[5]
Within microeconomics, elasticity and slope are closely linked. For price elasticity, the
relationship between the two variables on the x-axis and y-axis can be obtained by
analyzing the linear slope of the demand or supply curve or the tangent to a point on the
curve. When the tangent of the straight line or curve is steeper, the price elasticity
(demand or supply) is smaller; when the tangent of the straight line or curve is flatter,
the price elasticity (demand or supply) is higher.[6]
Elasticity is a unitless ratio, independent of the type of quantities being varied.
An elastic variable (with an absolute elasticity value greater than 1) responds more than
proportionally to changes in other variables. A unit elastic variable (with an absolute
elasticity value equal to 1) responds proportionally to changes in other variables. In
contrast, an inelastic variable (with an absolute elasticity value less than 1) changes
less than proportionally in response to changes in other variables. A variable can have
different values of its elasticity at different starting points. For example, for the suppliers
of the goods, the quantity of a good supplied by producers might be elastic at low prices
but inelastic at higher prices, so that a rise from an initially low price might bring on a
more-than-proportionate increase in quantity supplied. In contrast, a raise from an
initially high price might bring on a less-than-proportionate rise in quantity supplied.[7]
In empirical work, an elasticity is the estimated coefficient in a linear regression
equation where both the dependent variable and the independent variable are in natural
logs. Elasticity is a popular tool among empiricists because it is independent of units
and thus simplifies data analysis.[8]
The concept of price elasticity was first cited in an informal form in the book Principles
of Economics published by the author Alfred Marshall in 1890.[5] Subsequently, a major
study of the price elasticity of supply and the price elasticity of demand for US products
was undertaken by Joshua Levy and Trevor Pollock in the late 1960s.[9]

Definition[edit]
Elasticity is the measure of the sensitivity of one variable to another.[10] A highly elastic
variable will respond more dramatically to changes in the variable it is dependent on.
The x-elasticity of y measures the fractional response of y to a fraction change in x,
which can be written as
x-elasticity of y:
In economics, the common elasticities (price-elasticity of demand, price elasticity of
supply, and cross-price elasticity) all have the same form:
P-elasticity of Q: if continuous, or if discrete.

elastic Q changes more than P

unit elastic Q changes like P

inelastic Q changes less than P

Suppose price rises by 1%. If the elasticity of supply is 0.5, quantity rises by .5%;
if it is 1, quantity rises by 1%; if it is 2, quantity rises by 2%.
Special cases:
Perfectly elastic: ; quantity has an infinite response to even a small price change.
Perfectly inelastic: ; quantity does not respond at all to a price change.
Seller revenue (or, alternatively, consumer expenditure) is maximized
when (unit elasticity) because at that point a change in price is exactly
cancelled by the quantity response, leaving unchanged. To maximize
revenue, a firm must:
Relatively Elastic Demand: increase price if demand is inelastic:
reduce price if demand is elastic:
The elasticity of demand is different at different points of a
demand curve, so for most demand functions, including linear
demand, a firm following this advice will find some price at
which and further price changes would reduce revenue. (This is
not true for some theoretical demand functions: has an elasticity
of -.5 for any value of , so revenue rises infinitely as price rises to
infinity even though quantity approaches zero. See Isoelastic
function.)

perfect Q-elasticity of P: P is constant as Q changes

perfect Q-inelasticity of P: P changes while Q = constant

Conventional demand curve (downwards linear slope), with its elasticity

Example of demand curve with constant elasticity

 

Examples of supply curves with different elasticity

Examples of a non-linear supply curve with its elasticity

Types of Elasticity[edit]
Price Elasticity of Demand[edit]
Main article: Price elasticity of demand

Basic Formula for Price Elasticity of Demand

Price Elasticity of Demand measures sensitivity of demand to
price. Thus, it measures the percentage change in demand in
response to a change in price.[11] More precisely, it gives the
percentage change in quantity demanded in response to a one
per cent change in price (ceteris paribus, i.e. holding constant all
the other determinants of demand, such as income). Expressing
this mathematically, price elasticity of demand is calculated by
dividing the percentage change in the quantity demanded by the
percentage change in the price.[12]
If price elasticity of demand is calculated to be less than 1, the
good is said to be inelastic. An inelastic good will respond less
than proportionally to a change in price; for example, a price
increase of 40% that results in a decrease in demand of 10%.
Goods that are inelastic often have at least one of the following
characteristics: -Few, if any, available substitutes (eg precious
metals) -Essential goods (eg petrol) -Addictive goods (eg alcohol,
cigarettes) -Bought infrequently or a small percentage of income
(eg salt)
For goods with a high elasticity value, consumers will be more
sensitive to price changes. For the average consumer, an
increase in price of an inessential good with many available
substitutes will often result in that consumer not purchasing the
good at all, or purchasing one of the substitutes instead.[13]

Example: In the above graphical representation which shows an

effect of prices on demand. If the price of the Pizza is $20 at
which the quantity demanded is 5, if there is an increase in price
of pizza to $30 it will lead to decrease in quantity demanded to 3
which shows that small changes in the price of Pizza lead to
higher changes in quantity demanded.
Price Elasticity of Supply[edit]
Main article: Price elasticity of supply

Calculating Price Elasticity of

Supply
The Price Elasticity of Supply measures how the amount of a
good that a supplier wishes to supply changes in response to a
change in price.[14] In a manner analogous to the price elasticity of
demand, it captures the extent of horizontal movement along
the supply curve relative to the extent of vertical movement. If
supply elasticity is zero, the supply of a good supplied is "totally
inelastic", and the quantity supplied is fixed. It is calculated by
dividing the percentage change in quantity supplied by the
percentage change in price.[15]
The supply is said to be inelastic when the change in the prices
leads to small changes in the quantity of supply. Whereas the
elastic supply means the changes in prices causes higher
changes in the quantity supplied.
Income Elasticity of Demand[edit]
Main article: Income elasticity of demand
Income Elasticity of Demand is a measure used to show the
responsiveness of the quantity demanded of a good or service to
a change in the consumer income. Mathematically, this is
calculated by dividing the percentage change in the quantity
demanded by the percentage change in income.[16] Generally, a
higher income will increase quantity demanded as consumers will
be willing to spend more.
Cross-Price Elasticity of Demand[edit]
Main article: Cross elasticity of demand

Basic
Formula for Cross-Price Elasticity
Cross-Price Elasticity of Demand (or cross elasticity of demand)
measures the sensitivity between the quantity demanded in one
good when there is a change in the price of another good.[17] As a
common elasticity, it follows a similar formula to Price Elasticity of
Demand. Thus, to calculate it the percentage change in the
quantity of the first good is divided by the percentage change in
price in the second good.[17] The related goods that may be used to
determine sensitivity can be complements or substitutes.[11] Finding
a high-cross price elasticity between the goods may indicate that
they are more likely substitutes and may have similar
characteristics.[18] If cross-price elasticity is negative, the goods are
likely to be complements.
Real-world examples of cross-price elasticity:[19]

Product Under Investigation Comparison Product Price Elasticity

US Domestic Tuna Imported Tuna 0.45

US Domestic Tuna Bread -0.33

US Domestic Tuna Ground Meat 0.3

Beer Wine 0.2

 Beer Soft Drinks 0.3

Transit Automobiles 0.85

Transportation Recreation -0.05

Food Recreation 0.15

Clothing Food -0.18

Elasticity of Scale[edit]
Main article: Returns to scale
Elasticity of scale or output elasticity measures the percentage
change in output induced by a collective percent change in the
usages of all inputs.[20] A production function or process is said to
exhibit constant returns to scale if a percentage change in inputs
results in an equal percentage in outputs (an elasticity equal to 1).
It exhibits increasing returns to scale if a percentage change in
inputs results in greater percentage change in output (an elasticity
greater than 1). The definition of decreasing returns to scale is
analogous.[21][22][23][24]
 Principles of Economics (1890) --

Alfred Marshall Antoine Augustin

Cournot

Determinants of Elasticity[edit]
There are various factors that may affect elasticity, and these
factors differ for the types of elasticity.
Factors Affecting Price Elasticity of Demand[edit]
Availability of substitutes[edit]
If a product has various available substitutes that exist in the
market, it is likely that it would be elastic.[25] If a product has a
competitive product at a cheaper price in the market in which it
shares many characteristics with, it is likely that consumers would
deviate to the cheaper substitute. Thus, if many substitutions
existed in the market, a consumer would have more choices and
the elasticity of demand would be higher (elastic). In contrast, if
there were few substitutions that existed in the market, consumers
will have fewer choices and little to no available substitutes which
means elasticity of demand would be lower (inelastic).[25]
Product is necessity or Luxury[edit]
If a product is a necessity to the survival or daily life of a
consumer, it is likely to be inelastic.[26] This is due to the fact that if
a product is so intrinsically important to the daily life of a
consumer, a change in price is not likely to affect its demand.[1]
Time elapsed since price changed[edit]
If the price of a product is increasing and it has little available
substitutes, it is likely that the consumer will still continue to pay
this higher price.[1] The fact that the consumer needs the good in
the short-run, means that he is likely to continue this action
regardless in the long-run. This shows inelasticity of demand,
because even if there is a huge increase of a product's price,
there is no reduction of demand. However, if the consumer could
not afford the new price of the product, they would likely have to
learn to live without it, making the price elastic in the long-run.[25]
Percentage Income spent on the good[edit]
When the consumer spends a considerable portion of their
income on goods, it shows elastic demand. This indicates that a
change in the price of the goods will have a low impact on the
consumer's marginal consumption propensity. If the income spent
by the consumer on the goods is in a small proportion of their total
income which means the price elasticity of demand is low in such
case.[27]
Alternatively, we may also determine the factors affecting demand
elasticity by considering three “Intuitive factors. Firstly, we may
consider that there is different nature of elasticity when weighting
a “brand” of a product or a “category” of a product, a particular
brand of product is subject to elasticity as other brand may
replace it, while a “category” of a product may not be easily
replaced by other category of products. Secondly, like a
complementary product, there are some commodities that is
inelastic as buyer may have proceeding commitment to purchase
it in the future, such as vehicle spare part. Thirdly, consumer
mostly pay attention to product which cost a majority of share of
their spending, hence any change of price in this product or
services would be immediately affect consumer demand, hence
this kind of product is elastic, while a product which is not part of
consumer majority of purchase is inelastic due to “low involvement
to products” effect.[28]
Factors Affecting Price Elasticity of Supply[edit]
Availability of scarce resources in the market[edit]
It is one factor affecting the price elasticity of any industry if the
industry uses scarce resources to produce goods. If there is an
increase in demand for the goods, the company will not be able to
meet the demand because of the availability of resources. Thus, it
will increase the prices of the resources, leading to a
corresponding increase in the price of the producer goods.[29] For
example, Petrol is a natural resource, and thus it is scarce. If the
demand for Petrol increases as there is a scarcity of Petrol, it will
lead to an increase in petrol prices.
Number of Competitors in the Industry[edit]
It means that if the number of competitors is producing the same
goods, there is an easy supply of the goods and thus supply is
more inelastic with the increase in competitors.[30]
Others[edit]
Like Price Elasticity of Demand, time also affects Price Elasticity
of Supply. Though, there are other varying factors that affect this
too, such as: capacity, availability of raw materials, flexibility, and
the number of competitors in the market. Though, the time horizon
is arguably the most influential detriment to price elasticity of
supply.[15]
The longer the time horizon, the easier it is for commodity buyers
to choose alternative products (substitutes). Further, as the time
for suppliers to respond to price changes increases, a given price
change will have a more significant impact on supply. However,
suppliers can also hire more labour overtime, raise more funds,
build more new factories to expand production capacity, and
ultimately increase supply. In general, long-term supply is more
elastic than short-term supply because producers need some time
to adjust their ability to adapt to changes in demand.[31]

Applications[edit]
The concept of elasticity has an extensive range of applications in
economics. In particular, an understanding of elasticity is
fundamental in understanding the response of supply and
demand in a market.[12]
Elasticity is also an important concept for enterprises and
governments. For enterprises, elasticity is relevant in the
calculation of the fluctuation of commodity prices, and its relation
to income.
For enterprise, the concept of elasticity also can be applied for
pricing strategy. At one hand a businessman has to calculate as if
reducing price will necessarily increasing the demand of their
products, or will it not be necessary so and resolving a lost for the
company[32] At the other hand, enterprise have to consider whether
Increasing price and cutting production quantity led to greater
revenue.[33] To answer that, it is suggested that if the demand of
that product is elastic enough, it is profitable for enterprises to cut
price and let the demand to increase over time.[34] But in other
hand if the price is inelastic, it is profitable to cut the quantity of
production and let the price to rise, because as the product is
inelastic enough, so consumer have no alternative to purchase
other type of product or services to replace it. Though it is clear
that the enterprise should not let their product price to pass by that
inelasticity threshold, if so, then the product will be subject to price
elasticity and be affected by declining demand over time.[33]
For governments, the concept is important for the implementation
of taxation. When a government wants to increase taxes on
goods, it can use elasticity to judge whether increasing the tax
rate will be beneficial. Often, the demand for goods will be
significantly reduced when a government increases taxes on
them. Whilst a tax increase on inelastic goods will not impact their
demand, it may affect goods that are elastic. Aside from taxation,
elasticity can also assist in analysing the need for government
intervention.
Additionally, for essential goods, the government must ensure that
they are available to most consumers. Through setting price
ceilings and floors, the government is intervening by ensuring that
these goods are reasonably available.
As stated by British political economist David Ricardo, luxury
goods taxes have certain advantages over necessities taxes.
They are usually paid from income and, therefore, will not reduce
the country's production capital. For instance, when the price of
wine products rises due to increased taxes, consumers can give
up drinking wine.[35]
Other common uses of elasticity include:

 Analysis of incidence of the tax burden and other government

policies. See Tax incidence.
 Income elasticity of demand, used as an indicator of industry
health, future consumption patterns, and a guide to
firms' investment decisions. See Income elasticity of demand.
  Effect of international trade and terms of
trade effects. See Marshall–Lerner condition and Singer–
Prebisch thesis.
 Analysis of consumption and saving behavior. See Permanent
income hypothesis.
 Analysis of advertising on consumer demand for particular
goods. See Advertising elasticity of demand.
47