In economics, elasticity is the ratio of the percent change in one variable to the percent change in

another variable. It is a tool for measuring the responsiveness of a function to changes in

parameters in a unit-less way. Frequently used elasticities include price elasticity of demand,
price elasticity of supply, income elasticity of demand, elasticity of substitution between factors
of production and elasticity of intertemporal substitution.

Responsiveness of the demand for a good or service to the increase or decrease in its price.
Normally, sales increase with drop in prices and decrease with rise in prices. As a general rule,
appliances, cars, confectionary and other non-essentials show elasticity of demand whereas most
necessities (food, medicine, basic clothing) show inelasticity of demand (do not sell significantly
more or less with changes in price). See also cross price elasticity of demand.

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Elasticity is one of the most important concepts in economic theory. It is useful in understanding
the incidence of indirect taxation, marginal concepts as they relate to the theory of the firm, and
distribution of wealth and different types of goods as they relate to the theory of consumer
choice. Elasticity is also crucially important in any discussion of welfare distribution, in
particular consumer surplus, producer surplus, or government surplus.

In empirical work an elasticity is the estimated coefficient in a linear regression equation where
both the dependent variable and the independent variable are in natural logs. Elasticity is a
popular tool among empiricists because it is independent of units and thus simplifies data
analysis.

Generally, an "elastic" variable is one which responds "a lot" to small changes in other
parameters. Similarly, an "inelastic" variable describes one which does not change much in
response to changes in other parameters. A major study of the price elasticity of supply and the
price elasticity of demand for US products was undertaken by Hendrik S. Houthakker and Lester
D. Taylor.

Mathematical definition

The definition of elasticity is based on the mathematical notion of point elasticity.

In general, the "x-elasticity of y" is:

The "x-elasticity of y" is also called "the elasticity of y with respect to x".

[edit] Specific elasticities

[edit] Elasticities of demand

 Price elasticity of demand

Main article: Price elasticity of demand

Price elasticity of demand measures the percentage change in quantity demanded caused by a
percent change in price. As such, it measures the extent of movement along the demand curve.
This elasticity is almost always negative and is usually expressed in terms of absolute value. If
the elasticity is greater than 1 demand is said to be elastic; between zero and one demand is
inelastic and if it equals one, demand is unit-elastic.

 Income elasticity of demand

Main article: Income elasticity of demand

Income elasticity of demand measures the percentage change in demand caused by a percent
change in income. A change in income causes the demand curve to shift reflecting the change in
demand. YED is a measurement of how far the curve shifts horizontally along the X-axis.
Income elasticity can be used to classify goods as normal or inferior. With a normal good
demand varies in the same direction as income. With an inferior good demand and income move
in opposite directions.[2]

 Cross price elasticity of demand

Main article: Cross price elasticity of demand

Cross price elasticity of demand measures the percentage change in demand for a particular good
caused by a percent change in the price of another good. Goods can be complements, substitutes
or unrelated. A change in the price of a related good causes the demand curve to shift reflecting a
change in demand for the original good. Cross price elasticity is a measurement of how far, and
in which direction, the curve shifts horizontally along the x-axis. A positive cross-price elasticity
means that the goods are substitute goods.

 Cross elasticity of demand between firms

Main article: Conjectural variation

Cross elasticity of demand for firms, sometimes referred to as conjectural variation, is a measure
of the interdependence between firms. It captures the extent to which one firm reacts to changes
in strategic variables (price, quantity, location, advertising, etc.) made by other firms.

 Elasticity of intertemporal substitution

Main article: Elasticity of intertemporal substitution

 Combined Effects-

It is possible to consider the combined effects of two or more determinant of demand. The steps
are as follows: PED = (∆Q/∆P) x P/Q. Convert this to the predictive equation: ∆Q/Q =
PED(∆P/P) if you wish to find the combined effect of changes in two or more determinants of
demand you simply add the separate effects: ∆Q/Q = PED(∆P/P) + YED(∆Y/Y)[12] Remember
you are still only considering the effect in demand of a change is two of the variables. All other
variables must be held constant. Note also that graphically this problem would involve a shift of
the curve and a movement along the shifted curve.

[edit] Elasticities of supply

 Price elasticity of supply

Main article: Price elasticity of supply

The price elasticity of supply measures how the amount of a good firms wish to supply changes
in response to a change in price.[3] In a manner analogous to the price elasticity of demand, it
captures the extent of movement along the supply curve. If the price elasticity of supply is zero
the supply of a good supplied is "inelastic" and the quantity supplied is fixed.

 Elasticities of scale

Main article: Returns to scale

Elasticity of scale or output elasticities measure the percentage change in output induced by a
percent change in inputs.[4] A production function or process is said to exhibit constant returns to
scale if a percentage change in inputs results in a equal percentage in outputs (an elasticity equal
to 1). It exhibits increasing returns to scale if a percentage change in inputs results in greater
percentage change in output (an elasticity greater than 1). The definition of decreasing returns to
scale is analogous.[5]

Applications

The concept of elasticity has an extraordinarily wide range of applications in economics. In

particular, an understanding of elasticity is fundamental in understanding the response of supply
and demand in a market.
Some common uses of elasticity include:

 Effect of changing price on firm revenue. See Markup rule.

 Analysis of incidence of the tax burden and other government policies. See Tax
incidence.
 Income elasticity of demand can be used as an indicator of industry health, future
consumption patterns and as a guide to firms investment decisions. See Income elasticity
of demand.
 Effect of international trade and terms of trade effects. See Marshall–Lerner condition
and Singer–Prebisch thesis.
 Analysis of consumption and saving behavior. See Permanent income hypothesis.
 Analysis of advertising on consumer demand for particular goods. See Advertising
elasticity of demand
 When you raise the price of most items, people will buy less of them. For example, when one
airline raises its price, air passengers may switch to a rival airline.
When you reduce the price of most items, people will buy more of them. For example, when
supermarkets make special offers with reduced prices, they expect a sharp increase in
corresponding sales.
Common sense tells us that when prices change, so too will the quantities bought. However,
businesses need to have more precise information than this - they need to have a clear measure
of how the quantity demanded will change as a result of a price change.
The relationship between price and quantity demanded is measured by \'price elasticity of
demand\' (PED). This is calculated as: change in sales/% change in price

 Example 1

Suppose that a supermarket reduces the price of a packaged cake from £1.00 to 80p. Say sales
per week then rise from 500 to 700.
% change in sales = 200/500 = 40%
% change in price = 20p/100p = 20%
So PED = 40%/20% = 2.0
This tells us that demand for cakes is price elastic. Any change in price is magnified two-fold in
its effect on sales.

 Example 2

Now suppose that the supermarket increases the price of washing up liquid from £1.00 to £1.20.
Weekly sales drop only from 1,000 to 900 bottles.
% change in sales = 100/1000 = 10%
% change in price = 20p/100p = 20%
So PED = 10%/20% = 0.5
This tells us that the demand for washing up liquid is price inelastic. Any change in price in only
half the proportional effect on sales.
 Price elasticity data is very useful in making pricing decisions. Generally, the more the customer
has good substitutes available, the more demand will be price elastic.
Where there are few if any alternatives, price is usually inelastic. This principle leads to, for
example, fierce price competition among airlines flying to the USA (price elastic) but frequent
fare increases for commuters travelling by rail to London.
 

INCOME ELASTICITY

The Income Elasticity of Demand measures the rate of response of quantity demand due to a
raise (or lowering) in a consumers income. The formula for the Income Elasticity of Demand
(IEoD) is given by:

IEoD = (% Change in Quantity Demanded)/(% Change in Income)

Calculating the Income Elasticity of Demand

On an assignment or a test, you might be asked "Given the following data, calculate the income
elasticity of demand when a consumer's income changes from $40,000 to $50,000". (Your course
may use the more complicated Arc Income Elasticity of Demand formula. If so you'll need to see
the article on Arc Elasticity)Using the chart on the bottom of the page, I'll walk you through
answering this question.

The first thing we'll do is find the data we need. We know that the original income is $40,000
and the new price is $50,000 so we have Income(OLD)=$40,000 and Income(NEW)=$50,000.
From the chart we see that the quantity demanded when income is $40,000 is 150 and when the
price is $50,000 is 180. Since we're going from $40,000 to $50,000 we have
QDemand(OLD)=150 and QDemand(NEW)=180, where "QDemand" is short for "Quantity
Demanded". So you should have these four figures written down:

Income(OLD)=40,000
Income(NEW)=50,000
QDemand(OLD)=150
QDemand(NEW)=180

To calculate the price elasticity, we need to know what the percentage change in quantity
demand is and what the percentage change in price is. It's best to calculate these one at a time.

Calculating the Percentage Change in Quantity Demanded

The formula used to calculate the percentage change in quantity demanded is:
[QDemand(NEW) - QDemand(OLD)] / QDemand(OLD)

By filling in the values we wrote down, we get:

[180 - 150] / 150 = (30/150) = 0.2

So we note that % Change in Quantity Demanded = 0.2 (We leave this in decimal terms. In
percentage terms this would be 20%) and we save this figure for later. Now we need to calculate
the percentage change in price.

Calculating the Percentage Change in Income

Similar to before, the formula used to calculate the percentage change in income is:

[Income(NEW) - Income(OLD)] / Income(OLD)

By filling in the values we wrote down, we get:

[50,000 - 40,000] / 40,000 = (10,000/40,000) = 0.25

We have both the percentage change in quantity demand and the percentage change in income,
so we can calculate the income elasticity of demand.

Final Step of Calculating the Income Elasticity of Demand

We go back to our formula of:

IEoD = (% Change in Quantity Demanded)/(% Change in Income)

We can now fill in the two percentages in this equation using the figures we calculated earlier.

IEoD = (0.20)/(0.25) = 0.8

Unlike price elasticities, we do care about negative values, so do not drop the negative sign if
you get one. Here we have a positive price elasticity, and we conclude that the income elasticity
of demand when income increases from $40,000 to $50,000 is 0.8.

How Do We Interpret the Income Elasticity of Demand?

Income elasticity of demand is used to see how sensitive the demand for a good is to an income
change. The higher the income elasticity, the more sensitive demand for a good is to income
changes. A very high income elasticity suggests that when a consumer's income goes up,
consumers will buy a great deal more of that good. A very low price elasticity implies just the
opposite, that changes in a consumer's income has little influence on demand.
Often an assignment or a test will ask you the follow up question "Is the good a luxury good, a
normal good, or an inferior good between the income range of $40,000 and $50,000?" To answer
that use the following rule of thumb:

 If IEoD > 1 then the good is a Luxury Good and Income Elastic
 If IEoD < 1 and IEOD > 0 then the good is a Normal Good and Income Inelastic
 If IEoD < 0 then the good is an Inferior Good and Negative Income Inelastic

In our case, we calculated the income elasticity of demand to be 0.8 so our good is income
inelastic and a normal good and thus demand is not very sensitive to income changes.

PRICE ELASTICITY

The Price Elasticity of Demand (commonly known as just price elasticity) measures the rate of
response of quantity demanded due to a price change. The formula for the Price Elasticity of
Demand (PEoD) is:

PEoD = (% Change in Quantity Demanded)/(% Change in Price)

Calculating the Price Elasticity of Demand

You may be asked the question "Given the following data, calculate the price elasticity of
demand when the price changes from $9.00 to $10.00" Using the chart on the bottom of the
page, I'll walk you through answering this question. (Your course may use the more complicated
Arc Price Elasticity of Demand formula. If so you'll need to see the article on Arc Elasticity)

First we'll need to find the data we need. We know that the original price is $9 and the new price
is $10, so we have Price(OLD)=$9 and Price(NEW)=$10. From the chart we see that the
quantity demanded when the price is $9 is 150 and when the price is $10 is 110. Since we're
going from $9 to $10, we have QDemand(OLD)=150 and QDemand(NEW)=110, where
"QDemand" is short for "Quantity Demanded". So we have:

Price(OLD)=9
Price(NEW)=10
QDemand(OLD)=150
QDemand(NEW)=110

To calculate the price elasticity, we need to know what the percentage change in quantity
demand is and what the percentage change in price is. It's best to calculate these one at a time.

Calculating the Percentage Change in Quantity Demanded

The formula used to calculate the percentage change in quantity demanded is:
[QDemand(NEW) - QDemand(OLD)] / QDemand(OLD)

By filling in the values we wrote down, we get:

[110 - 150] / 150 = (-40/150) = -0.2667

We note that % Change in Quantity Demanded = -0.2667 (We leave this in decimal terms. In
percentage terms this would be -26.67%). Now we need to calculate the percentage change in
price.

Calculating the Percentage Change in Price

Similar to before, the formula used to calculate the percentage change in price is:

[Price(NEW) - Price(OLD)] / Price(OLD)

By filling in the values we wrote down, we get:

[10 - 9] / 9 = (1/9) = 0.1111

We have both the percentage change in quantity demand and the percentage change in price, so
we can calculate the price elasticity of demand.

Final Step of Calculating the Price Elasticity of Demand

We go back to our formula of:

PEoD = (% Change in Quantity Demanded)/(% Change in Price)

We can now fill in the two percentages in this equation using the figures we calculated earlier.

PEoD = (-0.2667)/(0.1111) = -2.4005

When we analyze price elasticities we're concerned with their absolute value, so we ignore the
negative value. We conclude that the price elasticity of demand when the price increases from $9
to $10 is 2.4005.

How Do We Interpret the Price Elasticity of Demand?

A good economist is not just interested in calculating numbers. The number is a means to an end;
in the case of price elasticity of demand it is used to see how sensitive the demand for a good is
to a price change. The higher the price elasticity, the more sensitive consumers are to price
changes. A very high price elasticity suggests that when the price of a good goes up, consumers
will buy a great deal less of it and when the price of that good goes down, consumers will buy a
great deal more. A very low price elasticity implies just the opposite, that changes in price have
little influence on demand.
Often an assignment or a test will ask you a follow up question such as "Is the good price elastic
or inelastic between $9 and $10". To answer that question, you use the following rule of thumb:

 If PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes)
 If PEoD = 1 then Demand is Unit Elastic
 If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

Recall that we always ignore the negative sign when analyzing price elasticity, so PEoD is
always positive. In the case of our good, we calculated the price elasticity of demand to be
2.4005, so our good is price elastic and thus demand is very sensitive to price changes.

CROSS-PRICE ELASTICITY

The Cross-Price Elasticity of Demand measures the rate of response of quantity demanded of one
good, due to a price change of another good. If two goods are substitutes, we should expect to
see consumers purchase more of one good when the price of its substitute increases. Similarly if
the two goods are complements, we should see a price rise in one good cause the demand for
both goods to fall. Your course may use the more complicated Arc Cross-Price Elasticity of
Demand formula. If so you'll need to see the article on Arc Elasticity. The common formula for
the Cross-Price Elasticity of Demand (CPEoD) is given by:

CPEoD = (% Change in Quantity Demand for Good X)/(% Change in Price for Good Y)

Calculating the Cross-Price Elasticity of Demand

You're given the question: "With the following data, calculate the cross-price elasticity of
demand for good X when the price of good Y changes from $9.00 to $10.00." Using the chart on
the bottom of the page, we'll answer this question.

We know that the original price of Y is $9 and the new price of Y is $10, so we have
Price(OLD)=$9 and Price(NEW)=$10. From the chart we see that the quantity demanded of X
when the price of Y is $9 is 150 and when the price is $10 is 190. Since we're going from $9 to
$10, we have QDemand(OLD)=150 and QDemand(NEW)=190. You should have these four
figures written down:

Price(OLD)=9
Price(NEW)=10
QDemand(OLD)=150
QDemand(NEW)=190

To calculate the cross-price elasticity, we need to calculate the percentage change in quantity
demanded and the percentage change in price. We'll calculate these one at a time.

Calculating the Percentage Change in Quantity Demanded of Good X

The formula used to calculate the percentage change in quantity demanded is:

[QDemand(NEW) - QDemand(OLD)] / QDemand(OLD)

By filling in the values we wrote down, we get:

[190 - 150] / 150 = (40/150) = 0.2667

So we note that % Change in Quantity Demanded = 0.2667 (This in decimal terms. In

percentage terms this would be 26.67%).

Calculating the Percentage Change in Price of Good Y

The formula used to calculate the percentage change in price is:

[Price(NEW) - Price(OLD)] / Price(OLD)

We fill in the values and get:

[10 - 9] / 9 = (1/9) = 0.1111

We have our percentage changes, so we can complete the final step of calculating the cross-price
elasticity of demand.

Final Step of Calculating the Cross-Price Elasticity of Demand

We go back to our formula of:

CPEoD = (% Change in Quantity Demanded of Good X)/(% Change in Price of Good Y)

We can now get this value by using the figures we calculated earlier.

CPEoD = (0.2667)/(0.1111) = 2.4005

We conclude that the cross-price elasticity of demand for X when the price of Y increases from
$9 to $10 is 2.4005.

How Do We Interpret the Cross-Price Elasticity of Demand?

The cross-price elasticity of demand is used to see how sensitive the demand for a good is to a
price change of another good. A high positive cross-price elasticity tells us that if the price of one
good goes up, the demand for the other good goes up as well. A negative tells us just the
opposite, that an increase in the price of one good causes a drop in the demand for the other
good. A small value (either negative or positive) tells us that there is little relation between the
two goods.
Often an assignment or a test will ask you a follow up question such as "Are the two goods
complements or substitutes?". To answer that question, you use the following rule of thumb:

 If CPEoD > 0 then the two goods are substitutes

 If CPEoD =0 then the two goods are independent (no relationship between the two goods
 If CPEoD < 0 then the two goods are complements

In the case of our good, we calculated the cross-price elasticity of demand to be 2.4005, so our
two goods are substitutes when the price of good Y is between $9 and $10.