Elasticities

Mastering price, income, cross elasticity of demand and price elasticity of supply is key to success in microeconomics.

Price elasticity of demand

• Definition: responsiveness of quantity demanded for a product to changes in price
• Calculation: % change in QD/% change in price
• Interpretation: Between 0 and -1 = price inelastic, less than -1 = elastic, 0 = perfectly inelastic, -infinity = perfectly elastic, -1 = unitary
• Determinants: availability of substitutes, luxury or necessity, expense of product as a % of income

Income elasticity of demand

• Definition: responsiveness of quantity demanded for a product to changes in income
• Calculation: % change in QD/% change in income
• Interpretation: less than 0 = inferior good, between 0 and 1 = normal necessity, more than 1 = normal luxury

Cross elasticity of demand

• Definition: responsiveness of quantity demanded for one product to a change in price of another product
• Calculation: % change in QD (product A)/% change in price (product B)
• Interpretation: more than 1 = strong substitutes, 0-1 weak substitutes, 0 = no relationship, 0 to -1 = weak substitutes, less than -1 = strong substitutes

Price elasticity of supply

• Definition: responsiveness of quantity supplied for a product to a change in price
• Calculation: % change in QS/% change in price
• Interpretation: 0 to 1 = price inelastic, more than 1 = price elastic, 0 = perfectly inelastic, infinity = perfectly elastic, 1 = unitary
• Determinants: Availability of stocks, time to make product, availability of factors of production

Usefulness of elasticities

• PED - used when setting prices to maximise revenue (inelastic = increase price, elastic = decrease price
• YED - used for estimating sales and planning stock in response to changes in income
• XED - used for strategy in responding to price changes of related products
• PES - there may be attempts to make more elastic enabling better responses to price changes, but difficult to alter

This information can be found in the form of a handy factsheet below