Elasticity is a measure of how responsive consumers and producers are to changes in prices. There are several types of elasticity. The price elasticity of demand reflects the change in quantity demanded that occurs when the price of a good rises or falls, all other things held constant. Taking into account elasticity can help determine the impact of price changes on a firm's total revenue as well. The income elasticity of demand is a measure of the change in quantity demanded that occurs in response to a change in a consumer's income. The cross-price elasticity of demand reflects how a change in the price of one good impacts the quantity demanded for another good. The sensitivity of sellers to changes in price is measured by the price elasticity of supply.
At A Glance
Elasticity measures how responsive a variable is to a change in a related variable.
- The price elasticity of demand measures consumers' responsiveness to price changes; it measures how much the quantity demanded for a good adjusts when there is a change in the good's price.
- To calculate the percentage change in either quantity demanded or price, use the midpoint formula.
- When the price elasticity of demand has an absolute value greater than 1, demand is elastic; when the price elasticity of demand has an absolute value less than 1, demand is inelastic.
- Five factors are used to determine the price elasticity of demand: the number of substitutes available, whether the good is a necessity or a luxury, the time frame considered, how broadly the market is defined, and the proportion of a consumer's budget accounted for by the good.
Perfectly elastic demand has an infinite price elasticity, while perfectly inelastic demand has a price elasticity of zero.
- Information about the price elasticity of demand enables firms or suppliers to determine the impact of price changes on a firm's total revenue.
- When demand is elastic, small changes in price correlate to large changes in quantity demanded.
- When demand is inelastic, changes in price have little effect on quantity demanded.
- When demand is unit elastic, the percentage change in quantity demand is the same as the percentage change in price.
- The income elasticity of demand measures how responsive demand is to changes in consumers' income.
- The cross-price elasticity of demand measures how responsive consumer demand for one good is to changes in the price of a second good.
- The price elasticity of supply reflects the sensitivity of producers to changes in price.
- Supply is elastic when the price elasticity of supply is greater than 1; when the price elasticity of supply is less than 1, supply is inelastic.
- Theoretically, price elasticity of supply can range from zero (perfectly inelastic) to infinity (perfectly elastic).