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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Elasticity

What is Elasticity in Economics?

Elasticity is a measure of how much the quantity demanded of a service/good changes in relation to its price, consumer income or supply.

Elasticity of Demand Formula and Examples

While there are several types of elasticity in economics (see below), the most commonly used is demand elasticity (aka price elasticity), which shows how consumer demand is affected when prices go up or down.

The formula for demand elasticity is:

Demand Elasticity = (% Change in Quantity Demanded) / (% Change in Price)

If demand elasticity is greater than one, the good or service is considered price sensitive and elastic. If the elasticity of a good or service is less than one, it is considered price insensitive and inelastic. We'll walk through some examples of how elastic and inelastic concepts work below.

Elastic Goods and Services

Elastic goods and services generally have plenty of substitutes. As an elastic service/good's price increases, the quantity demanded of that good can drop fast.

For example, lets say the price of Cable TV Service A goes up by 10%. Because consumers can easily switch to less-expensive Cable TV Service B or other forms of entertainment, cable subscribers (quantity) for Cable TV Service A fall by 15%. In this case:

Demand Elasticity = 15% / 10% = 1.5

In other words, for every 1% increase in service price, the company can expect to lose 1.5% of its subscribers. This shows how elastic (or price sensitive) the cable tv service is, as the quantity demanded changes at a larger rate than the price.

Other examples of elastic goods and services include furniture, motor vehicles, instrument engineering products, professional services, and transportation.

Inelastic Goods and Services

Inelastic goods have fewer substitutes and price change doesn't affect quantity demanded as much.

The most famous example of relatively inelastic demand is that for gasoline. As the price of gasoline increases, the quantity demanded doesn't decrease all that much. Even if gas prices are high, consumers are still willing to buy it because they still need to commute and there are very few good substitutes for gasoline.

Let's say gas prices increased by 50% and consumer demand (quantity) only fell by 5%. That would mean gas' elasticity was:

Demand Elasticity = 5% / 50% = 0.1

Put another way, for every 10% rise in price, gas demand would only be expected to fall by 1%. With an elasticity of less than 1, that means this good is very inelastic. 

More examples of inelastic goods include electricity, water, drinks, clothing, tobacco, food, and oil. 

Elasticity of Supply and Income Elasticity

To learn more about other types of elasticity, see the following:

Income Elasticity of Demand: the responsiveness of quantity demanded to a change in income.

Price Elasticity of Demand (PED): the responsiveness of quantity demanded to a change in  price.

Elasticity of Supply: the responsiveness of the quantity supplied to a change in price.