Elasticity

Consumers are more sensitive to some price changes than to others. You may not want to buy a car if its price goes up 10 percent. But if the price of salt goes up 10%, you will pay extra amount rather than go without salt. The degree to which changes in price cause changes in quantity demanded is called elasticity of demand. The number of cars demanded changes greatly as car prices change; so the demand for cars is highly elastic. The demand for salt is more inelastic: people buy nearly the same amount even though the price of salt changes. There are two basic reasons for elasticity of demand. The first concerns the relationship between income and the cost of the product. A car, for example, may easily cost 50% of your annual income. Salt probably costs less than 50% of your annual income. The smaller the proportion of your income that a product costs, the more inelastic is its demand. Demand tends to be more elastic if the good is a luxury rather than a necessity. The second reason why demand is elastic concerns whether or not substitute product is available.

Elasticity, a measure of how much buyers and sellers respond to changes in market conditions, allows analyzing supply and demand with greater precision.

Economists use the term ’elasticity of demand’ to describe the responsiveness of one variable (demand) to another variable (price). The degree to which changes in price cause changes in quantity demanded is called the price elasticity of demand. The price elasticity of demand (ED) can be expressed by the following equation:

This is defined as the percentage change in quantity demanded, divided by the percentage change in price.

This value varies between zero and infinity. Three ranges are identified:

—elastic, very responsive to price changes - greater than 1;

—unit elasticity;

—inelastic, not very responsive to price changes - less than 1.

Ex. 1. Based on your understanding of the text, are the following TRUE or FALSE? Explain why.

1. The concept of elasticity looks at how much one factor changes as a result of some other factor changing.

2. Elasticity, a measure of how much buyers respond to changes in market conditions, allows analyzing demand with greater precision.

3. The smaller the proportion of your income that a product costs, the more elastic is its demand.

4. Elasticity is a planning tool for managers.

Ex. 2. Answer the questions on the text.