- Elasticity
is a measure of sensitivity of change in one variable as a result
of the change in another variable. The price elasticity of demand
measures the degree of responsiveness, or sensitivity, of quantity
demanded to changes in the price of the product. More specifically,
the price elasticity of demand is is the percentage change in quantity
demanded resulting from a 1 percent change in price, (% change
in quantity demanded divided by the % change in the price).
- Convention
indicates that we give the elasticity coefficient a positive sign,
even though the change in price is positive and the change in quantity
is negative -- or vice versa).
The price elasticity of demand is likely to vary from one point to
another on the demand curve. For example, the price elasticity of
demand for slingshots may be higher when a slingshot costs $1 than
when it costs $.25.
- Note
that the price elasticity of demand is expressed in terms of relative
- that is, proportional or percentage - changes in price and quantity
demanded, not absolute changes. This is because absolute changes depend
on the units in which price and quantity are measured. For example,
the percentage change in price is the same regardless of whether price
is measured in dollars or cents. And the percentage change in quantity
demanded is the same, regardless of whether it is measured in pounds,
tons, or dozens.
- The
determinants of the price elasticity of demand are: (a) number and
availability of close substitutes; (b) Proportion of consumers' budgets;
(c) Length of the period; (d) Whether the good is a necessity or a
luxury; and (e) How narrowly or broadly the good is defined.
Price elasticity of demand can be classified as: (a) elastic (coefficient
is greater than 1); (b) inelastic (coefficient is less than 1(; (c)
unit or unitary elastic (coefficient is equal to 1); (d) perfectly
elastic (coefficient is undefined or infinity); and (e) perfectly
inelastic (coefficient is equal to zero).
- Income
elasticity of demand is defined as the percentage change in demand
resulting from a 1% change in total income (all prices being held
constant). A good's income elasticity of demand may be positive or
negative. For many commodities, increases in income result in increases
in demand. Such commodities, like steak or caviar, have positive coefficients,
and are called superior or normal goods. For a few commodities, increases
in income result in decreases in demand. These commodities, like poor
grades of vegetables, have negative income elasticities of demand.
However, be careful to note that the income elasticity of demand of
a commodity is likely to vary with the level of income under consideration.
For example, if only families at the lowest income level are considered,
the income elasticity of demand for poor grades of vegetables may
be positive. Luxury items tend to have higher income elasticities
of demand than necessities. Indeed, one way to define luxuries and
necessities is to say that luxuries are commodities with high income
elasticities of demand, and necessities are commodities with low income
elasticities of demand.
- Cross
elasticity of demand is defined as the % change in the demand
of one commodity resulting from a 1% change in the price of another
commodity. Some pairs of commodities can be classified as substitutes
or complements, depending on the sign of the cross elasticity of demand.
If the cross elasticity of demand is positive, two commodities are
substitutes. Butter and margarine are substitutes because a decrease
in the price of butter will result in a decrease in demand for margarine.
On the other hand, if the cross elasticity of demand is negative,
two commodities are complements. For example, gin and tonic may be
complements, since a decrease in the price of gin may increase the
demand for tonic, since gin and tonic tend to be used together.
- Price
elasticity of supply is defined as the % change in the quantity
supplied as a result of a 1% change in the price of the product. The
main determinant of the price elasticity of supply is time. The longer
the time period, the more elastic supply becomes.
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