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Elasticity

Elasticity indicates the number of consumers and suppliers who respond to changes (e.g. price changes, income change) in the market.  It is essential in determining the supply and demand curves accurately.

There are three common type of elasticity:

 

  • Price Elasticity of Demand
  • Price Elasticity of Supply
  • Income Elasticity

 

 

Price Elasticity of Demand

 

The percent change in the price that would cause the percent change in the quantity demanded.

 

 

There are several terms that describe the elasticity of a particular goods or service:

  • Perfectly Inelastic: Consumers are not responding to price changes. It is indicated as a vertical line on the graph.
  • Perfectly Elastic: Consumers are extremely responsive to price changes. It is indicated as a horizontal line on the graph.
  • Unit Elastic: Consumers are responding in direct proportion to the price changes. It is indicated as a increasing straight line in which the slope = 1.

Demand tends to be more inelastic if:

a)      the good is a necessity,

b)      the adjustment time is shorter,

c)       there are fewer substitutes, and

d)      the market is larger and broader

 

Price Elasticity of Demand = % Change in Quantity Demanded/ % Change in Price

 

 

Price Elasticity of Supply

 

The percent change in the price that would cause the percent change in the quantity supplied.

 

Supply tends to be more inelastic if:

a) the supplier has less flexibility

b) the amount of goods to produce is hard to alter

c) the adjustment time is shorter, i.e. in a short run

 

Goods that are more flexible include books, clothes, and shoes.

Goods that are less flexible may include cars and seasonal agricultural products.

 

 

Price Elasticity of Supply = % Change in Quantity Supplied/ % Change in Price

 

 

Income Elasticity

 

The percent change in the income that would cause the percent change in the quantity demanded.

 

 

Normal goods versus inferior goods

 

Higher income = higher demand of normal goods

 

Higher income = lower demand of inferior goods* since consumers tend to buy goods with a higher quality when they have a higher income

 

*Inferior goods are low-quality goods.

 

 

 

Necessities versus Luxuries

 

Necessities tend to be income inelastic since consumers need them no matter how much money they earn. 

Some examples of necessities include food, fuel, and health care services

Luxuries tend to be income elastic since consumers only buy them when they have a higher income

Some examples of luxuries include luxury cars, 3-storey houses, and designer-brand clothes

 

 

Income Elasticity= % Change in Quantity Demanded/ % Change in Income

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