Elasticity

Elasticity is a measure of the responsiveness of one variable to changes in another. In economics, elasticity is often used to measure the responsiveness of demand or supply to changes in price.

Price elasticity of demand measures the responsiveness of quantity demanded to changes in price. A good with elastic demand is one whose quantity demanded changes significantly in response to a change in price. A good with inelastic demand is one whose quantity demanded changes little in response to a change in price.

The price elasticity of demand is calculated as follows:

$$\text{Price elasticity of demand} = \frac{\%\text{ change in quantity demanded}}{\%\text{ change in price}}$$

For example, if a 10% increase in price leads to a 20% decrease in quantity demanded, then the price elasticity of demand is -2.

The price elasticity of demand is important because it can be used to predict how changes in price will affect total revenue. If demand is elastic, then a price increase will lead to a decrease in total revenue. If demand is inelastic, then a price increase will lead to an increase in total revenue.

Income elasticity of demand measures the responsiveness of quantity demanded to changes in income. A good with a positive income elasticity of demand is one whose quantity demanded increases as income increases. A good with a negative income elasticity of demand is one whose quantity demanded decreases as income increases.

The income elasticity of demand is calculated as follows:

$$\text{Income elasticity of demand} = \frac{\%\text{ change in quantity demanded}}{\%\text{ change in income}}$$

For example, if a 10% increase in income leads to a 20% increase in quantity demanded, then the income elasticity of demand is 2.

The income elasticity of demand is important because it can be used to predict how changes in income will affect total revenue. If demand is income elastic, then a decrease in income will lead to a decrease in total revenue. If demand is income inelastic, then a decrease in income will lead to an increase in total revenue.

Cross-price elasticity of demand measures the responsiveness of quantity demanded of one good to changes in the price of another good. A good with a positive cross-price elasticity of demand is one whose quantity demanded increases when the price of another good decreases. A good with a negative cross-price elasticity of demand is one whose quantity demanded decreases when the price of another good decreases.

The cross-price elasticity of demand is calculated as follows:

$$\text{Cross-price elasticity of demand} = \frac{\%\text{ change in quantity demanded of good A}}{\%\text{ change in price of good B}}$$

For example, if a 10% decrease in the price of good B leads to a 20% increase in the quantity demanded of good A, then the cross-price elasticity of demand is 2.

The cross-price elasticity of demand is important because it can be used to predict how changes in the price of one good will affect the demand for another good. If the cross-price elasticity of demand is positive, then the two goods are substitutes. If the cross-price elasticity of demand is negative, then the two goods are complements.