Fundamentals of Economics
Elasticity is a measure of the responsiveness of one economic variable to changes in another. When the price of a good changes, for example, we expect the quantity demanded to change as well. Elasticity helps us understand how much the quantity demanded will change in response to a change in price. Elasticity can also be applied to other variables, such as income or the price of a complementary good.
The formula for price elasticity of demand is:
$$ \text{Price Elasticity of Demand} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}} $$
If the price elasticity of demand is greater than 1, we say that demand is elastic. This means that a small change in price leads to a relatively large change in the quantity demanded. If the price elasticity of demand is less than 1, we say that demand is inelastic. This means that a change in price has a relatively small effect on the quantity demanded. If the price elasticity of demand is exactly 1, we say that demand is unit elastic.
For example, suppose the price of a good increases from $10 to $12, and the quantity demanded falls from 100 to 90. The percentage change in price is 20%, while the percentage change in quantity demanded is -10%. The price elasticity of demand is:
$$ \text{Price Elasticity of Demand} = \frac{-10%}{20%} = -0.5 $$
Since the price elasticity of demand is less than 1, we say that demand is inelastic.
Elasticity is an important concept in economics because it helps us understand how consumers and producers respond to changes in market conditions. It also helps us predict how changes in policy, such as taxes or subsidies, will affect behavior in the market.
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