Elasticity in Economics

Overview

This lecture introduces the concept of elasticity in economics, explaining its types, determinants, calculations, and real-world business applications.

What is Elasticity?

• Elasticity measures how much the quantity demanded or supplied changes in response to a price change.
• It shows how sensitive consumers and producers are to price changes.

Types of Elasticity

• Price Elasticity of Demand: Measures how much the quantity demanded changes when the price changes.
  • Demand is elastic if consumers quickly adjust buying when prices change; inelastic if they do not.
  • Determined by:
    • Availability of substitutes: More substitutes mean more elastic demand.
    • Necessity vs. luxury: Necessities have inelastic demand; luxuries are more elastic.
    • Time horizon: Demand is more elastic in the long run.
• Price Elasticity of Supply: Measures how much the quantity supplied changes when the price changes.
  • Supply is elastic if producers adjust output quickly to price changes; inelastic if they cannot.
  • Determined by:
    • Availability of inputs: Easier access increases elasticity.
    • Time period: Supply is more elastic in the long run.
    • Flexibility of production: More flexible production increases elasticity.

Calculating Elasticity

• Price Elasticity of Demand (PED) formula: % change in quantity demanded ÷ % change in price.
  • Elastic if absolute value > 1; inelastic if < 1; unitary if = 1.
  • Example: 5% price increase and 10% demand drop → PED = -2 (elastic).
• Price Elasticity of Supply (PES) formula: % change in quantity supplied ÷ % change in price.
  • Supply is elastic if PES > 1; inelastic if PES < 1.

Real-World Applications

• Pricing Strategies: Elasticity guides pricing to maximize revenue depending on consumer sensitivity.
• Product Line Decisions: Helps decide which products to promote or position as premium.
• Market Entry/Expansion: Determines price strategies for entering or expanding in new markets.

Key Terms & Definitions

• Elasticity — Measure of how responsive quantity demanded or supplied is to price changes.
• Price Elasticity of Demand (PED) — Degree of change in demand due to a price change.
• Price Elasticity of Supply (PES) — Degree of change in supply due to a price change.
• Elastic Demand/Supply — Large response to price changes (absolute value > 1).
• Inelastic Demand/Supply — Small response to price changes (absolute value < 1).

Action Items / Next Steps

• Review key formulas for PED and PES.
• Consider real-world examples of elasticity for homework or discussion.