Applications of Elasticities

In economics, elasticity refers to how the supply and demand of a product changes in relation to a change in the price.

Learning Objective

Give examples of inelastic and elastic supply in the real world

Key Points

To determine the elasticity of a product, the proportionate change of one variable is placed over the proportionate change of another variable (Elasticity = % change of supply or demand / % change in price).
For elastic demand, a change in price significantly impacts the supply and demand of the product.
For inelastic demand, a change in the price does not substantially impact the supply and demand of the product.
Economists use demand curves in order to document and study elasticity.

Terms

elastic
Sensitive to changes in price.
supply
The amount of some product that producers are willing and able to sell at a given price, all other factors being held constant.
inelastic
Not sensitive to changes in price.
demand
The desire to purchase goods and services.

Example

If the per gallon price of water increases from $10 to $11, there is a 10% increase in price. As a result of the price increase, the demand for water drops from 100 gallons to 99 gallons of water per day, which is a 1% decrease. In this case, the price increase of water is inelastic because it does not substantially impact the supply and demand (there is only a 1/10 change in demand).

Full Text

In economics, elasticity refers to the responsiveness of the demand or supply of a product when the price changes.

The technical definition of elasticity is the proportionate change in one variable over the proportionate change in another variable. For example, to determine how a change in the supply or demand of a product is impacted by a change in the price, the following equation is used: Elasticity = % change in supply or demand / % change in price.

The price is a variable that can directly impact the supply and demand of a product. If a change in the price of a product significantly influences the supply and demand, it is considered "elastic." Likewise, if a change in product price does not significantly change the supply and demand, it is considered "inelastic."

For elastic demand, when the price of a product increases the demand goes down. When the price decreases the demand goes up. Elastic products are usually luxury items that individuals feel they can do without. An example would be forms of entertainment such as going to the movies or attending a sports event. A change in prices can have a significant impact on consumer trends as well as economic profits. For companies and businesses, an increase in demand will increase profit and revenue, while a decrease in demand will result in lower profit and revenue.

For inelastic demand, the overall supply and demand of a product is not substantially impacted by an increase in price. Products that are usually inelastic consist of necessities like food, water, housing, and gasoline. Whether or not a product is elastic or inelastic is directly related to consumer needs and preferences. If demand is perfectly inelastic, then the same amount of the product will be purchased regardless of the price.

Economists study elasticity and use demand curves in order to diagram and study consumer trends and preferences. An elastic demand curve shows that an increase in the supply or demand of a product is significantly impacted by a change in the price . An inelastic demand curve shows that an increase in the price of a product does not substantially change the supply or demand of the product .

Inelastic Demand

For inelastic demand, when there is an outward shift in supply and prices fall, there is no substantial change in the quantity demanded.

Elastic Demand

For elastic demand, when there is an outward shift in supply, prices fall which causes a large increase in quantity demanded.

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