- Elasticity
- Elasticity is an economics concept that measures the responsiveness of one variable to changes in another variable.
- Price elasticity of demand
- The price elasticity of demand is the percentage change in the quantity demanded of a good divided by the percentage change in its price.
Decisions that turn on an elasticity
Can you name the four decisions an elasticity estimate helps to make?
Each decision needs a different elasticity, so the first step is to pick the right one.
Setting a price uses the price elasticity of demand: a firm raises revenue by raising its price where demand is inelastic and by cutting it where demand is elastic.
Can you think of an example?
A theatre finds its matinee demand is elastic and its Saturday-night demand inelastic, so it cuts matinee prices by £5 and raises Saturday prices by £5.
Planning for changing incomes uses the income elasticity of demand, because how far a good's demand curve shifts when incomes change depends on it.
Can you think of an example?
A supermarket expects real incomes to fall, so it stocks more of its value range, which has a negative income elasticity, and fewer premium ready meals.
Pricing related goods uses the cross-price elasticity of demand, which shows how far a change in one good's price moves demand for another.
Can you think of an example?
A printer maker sells printers cheaply because the cross elasticity between printers and its own ink is strongly negative: every extra printer sold means more ink sold.
Taxing and subsidising uses the elasticities of demand and supply, which decide how much a tax raises and cuts consumption, and how far a subsidy raises output.
Can you think of an example?
A tax on a good with inelastic demand, such as cigarettes, raises a lot of revenue but cuts consumption little, and buyers bear most of it.