What Is Elasticity?
Elasticity is a measure of how much the quantity demanded of a service or good changes in relation to its price, consumer income, or supply.
What Is the Elasticity Formula?
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 to be price-sensitive and therefore elastic. If the demand elasticity of a good or service is less than one, it is considered to be price-insensitive and relatively inelastic. We'll walk through some examples of how elastic and inelastic concepts work below.
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 quickly.
For example, let’s 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 their subscribers. This shows how elastic (or price-sensitive) the cable TV service industry is, as the quantity demanded changes at a larger rate than the price.
Other examples of elastic goods and services include furniture, motor vehicles, professional services, and transportation.
Elastic vs. Inelastic Demand
The most common example of relatively inelastic demand is for gasoline. As the price of gasoline increases, the quantity demanded does not decrease significantly. Even if gas prices are high, consumers are still willing to buy it because they still need to drive for work and there are currently very few viable substitutes for gasoline. Gasoline is considered a “necessity good.”
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
Stated another way, for every 10% rise in price, demand for gasoline would only be expected to fall by 1%. With an elasticity of less than 1, that means this good is very inelastic as the demand is almost constant.
Elasticity of Supply
Interestingly, although gasoline is relatively inelastic from a consumer perspective, oil and gas producers continually adjust their output (or supply) for changes in both the price of a barrel of oil. Since oil is a global market, supply in other countries certainly plays a role as well, which is the role of OPEC to coordinate between member countries across the world.
Elasticity of Demand
Elasticity of demand is the responsiveness of the quantity demanded of a commodity to changes in one of the variables on which demand depends. It is calculated as the percentage change in quantity demanded divided by the percentage in one of the variables on which demand depends.
Other types of elasticity are the income elasticity of demand, which is the responsiveness of quantity demanded to a change in income, and price elasticity of demand (PED), which is the responsiveness of quantity demanded to a change in price.
Elasticity is an important economic measure for the sellers of goods or services because it measures the amount buyers will consume when the price inevitably changes. The theory of elasticity of demand is an integral part of product pricing and marketing strategies.
When a product is elastic, a change in price quickly results in a change in the quantity demanded—this is important because the seller needs to be aware of the ripple effects of pricing fluctuation.