Elasticity

Introduction

I can imagine a more or less elastic thread, a pair of pants that is elastic at the waist, or a T-shirt made of elastic fabric, but why would we talk about elasticity on an economics page?

Elasticity is a key concept in economics, and in simple terms it measures the sensitivity of a given variable to changes in another. Many times -perhaps even unconsciously- a change in a certain factor makes us decide differently in relation to another. For example, a young person may choose to go out more or less with his friends in relation to the weather, or a student may decide to spend more or less hours studying in relation to the number of books included in the bibliography of an exam. When we study economic variables, these types of relationships occur all the time: people may for example decide to demand less of a good when its price rises; or increase the desire to consume another good when their income increases; or they may even desire more (or less) to buy good A, if good B rises in price. All these relationships are captured by the concept of “elasticity”.

How is it measured?

“Changes in variable A / changes in variable B = elasticity of A with respect to B.”

What kinds of elasticity do we know?

As we said, one could find the elasticity of any variable with respect to any other variable to which one considers it to be linked. Let us use as an example the most frequently used elasticity in economics:

Price elasticity of demand

The price elasticity of demand shows what happens to the quantities demanded of a given good in the face of increases in its price. Although we know that demand curves generally have a negative slope (the higher the price, the lower the quantity demanded, and the lower the price, the higher the quantity demanded), the fact is that the sensitivity of demand to changes in price is not unequivocal. Thus, for example, it is likely that the quantities demanded for insulin or a much needed good will vary little even with significant changes in price, while an increase in the market for cherry tomatoes may quickly lead to a significant reduction in the demand for cherry tomatoes as they are replaced by other types of tomatoes.

Calculation of the price elasticity of demand:

Percentage change in quantities demanded / percentage change in price = price elasticity of demand.

How to classify goods according to the price elasticity of demand:

If the percentage change in quantities demanded is greater than the percentage change in price, we speak of an elastic demand.

If the percentage change in the quantities demanded is less than the percentage change in price, we speak of an inelastic demand.

If the percentage change in quantities demanded is equal to the percentage change in price, we speak of an elastic unitary demand.

Other elasticities used:

Income elasticity of demand: measures the sensitivity of demand for a good to changes in the real income of the population. According to the result, goods can be classified as: inferior (when, as the population's income increases, the quantities demanded of the good decrease); basic goods (when the demand increases less than the income); or luxury goods (when the quantities demanded increase more than proportionally to the income).

Cross-elasticity of demand: measures the variation in the quantities demanded of a good in response to changes in the price of another good. This can guide us about substitute goods (when, as the price of one good rises, the quantities of another increases) or complementary goods (when, as the price of one good rises, the quantities demanded of another fall).

Price elasticity of supply: measures the variation in the quantities offered of a good in the face of price increases.

Why is the concept of elasticity relevant for economic policy?

As we have seen, the concept of elasticity is key to analyzing the potential impact that a change in one variable could have on another with which it is indirectly related. Thus, for example, a policymaker could study how much the economy must grow to generate an increase in the amount of employment (the employment elasticity of output), or how economic growth could generate a balance of payments problem due to an increased demand for imports (income elasticity of imports).