Elasticity

Published Dec 24, 2022

Definition of Elasticity

Elasticity is a measure of how responsive an economic variable is to a change in another economic variable. That means it measures the degree to which a change in one variable (e.g., price) causes a change in another variable (e.g., quantity demanded).

Example

To illustrate this, let’s look at the demand for apples. Imagine the price of apples increases from USD 1.00 to USD 1.50. As a result, the quantity demanded decreases from 100 to 80. In this case, the elasticity of demand is -0.4 (-20%/50%). That means a 50% increase in price leads to a 20% decrease in quantity demanded.

On the other hand, if the price of apples increases from USD 1.00 to USD 1.50, but the quantity demanded only decreases from 100 to 95, the elasticity of demand is -0.1 (i.e., -5%/50%). That means a 50% increase in price leads to a 5% decrease in quantity demanded.

Why Elasticity Matters

Elasticity is an important concept for understanding how markets work. It helps economists and business owners to understand how changes in one variable (e.g., price) will affect another variable (e.g., quantity demanded). This knowledge can then be used to make better decisions about pricing, production, and other aspects of the business.

In addition, elasticity is also used to measure the impact of taxes and subsidies on the economy. For example, if a tax is imposed on a good that has an elastic demand, the tax will lead to a decrease in the quantity demanded and an increase in the price. On the other hand, if the demand is inelastic, the tax will lead to an increase in the price but not a decrease in the quantity demanded.