What Does Inelastic Mean?
Something is inelastic when its price does not vary with the price of another item. It the business world, the term most often refers to how little the price of a good or service changes when the supply of that good or service changes.
The formula for elasticity is:
Elasticity = % Change in Quantity/% Change in Price
How Does Inelasticity Work?
Let's assume that when gas prices increase by 50%, gas purchases fall by just 2%. Using the formula above, we can calculate that gasoline is pretty inelastic:
Elasticity = -2%/50% = -0.04
Thus, we can say that for every percentage point that gas prices increase, gas purchases decrease by four one-hundredths of a percent. The price of gas is inelastic.
Why Does Inelasticity Matter?
If demand changes a lot when prices change a little, the demand for a product is elastic. This often is the case for products or services for which there are many alternatives or for which consumers are price sensitive.
The opposite is also true: When there is a small change in demand when prices change a lot, the product is inelastic. This is often the case for products and services that people consider necessities and will purchase at almost any price. The presence of few good substitutes and the presence of customer loyalty are also factors. At some point, however, there is a price at which demand for any good or service will fall to zero or near zero.