What Is Elasticity? Meaning, Types & Importance In Economics

Elasticity is the responsiveness of one variable when another variable changes. It calculates how much supply or demand shifts when there is a change in:

• Price
• Income
• Other influencing factors
   

Let’s say Karan is a local fruit vendor. He sells mangoes at ₹100 per dozen. Due to market forces, he increases the price to ₹120 per dozen. Consequently, buyers respond by lowering their order sizes.

Also, some switch to buying papayas priced at ₹70 per dozen. The decline in mango sales due to a price increase is a practical example of elasticity.

Meaning Of Elasticity In Economics

It provides us with a way to understand how we respond to changes in price, income, or the price of other goods. 

In simple words:

• If a small change in price leads to a large shift in demand or supply, the item is considered elastic.
   
• If demand or supply barely changes despite a price increase or drop, it is inelastic.
   

It is a key concept that helps producers, retailers, and policymakers plan better.

Types Of Elasticity In Economics

Elasticity is mainly classified into four types. Each type focuses on how different factors affect demand or supply.

1. Price Elasticity of Demand (PED)

This is the most common type of elasticity. With this concept, you can understand how buyers react when product prices go up or down, affecting the quantity purchased.

Formula:

Price Elasticity of Demand = % Change in Quantity Demanded ÷ % Change in Price 

Example:

The price of stainless steel bottles goes up from ₹200 to ₹240 (a 20% increase). Due to this, the quantity demanded falls from 1000 units to 800 units (a 20% fall).

PED = −20% ÷ 20% = −1
 

So, the demand in the example is said to be unit elastic. 

2. Income Elasticity of Demand (YED)

It shows how the quantity demanded changes as consumers' income changes.

Formula:

Income Elasticity of Demand = % Change in Quantity Demanded ÷ % Change in Income 

Example:

If your income rises by 15%. Also, the demand for air conditioners goes up by 30%:

YED = 30% ÷ 15% = 2 
 

So, the demand in the example is said to be for luxury goods. 

3. Cross Elasticity of Demand (XED)

You can use it to measure how the demand for one good responds when the price of another good changes.

Formula:

Cross Elasticity of Demand = % Change in Demand for Good A ÷ % Change in Price of Good B

Example:

If the price of Pepsi increases by 10%. Due to this, the demand for Coke increases by 6%:

XED = 6% ÷ 10% = 0.6 
 

So, the demand in the example is said to be for substitute goods. 

4. Price Elasticity of Supply (PES)

It refers to how supply changes in response to a change in price. It is beneficial for producers and farmers.

Formula:

PES = % Change in Quantity Supplied ÷ % Change in Price 

Example:

If wheat prices increase by 30%. Due to this, farmers increase supply by 60%:

PES = 60% ÷ 30% = 2 
 

So, the above-mentioned example indicates elastic supply.

Importance Of Elasticity In Economics

If you think that elasticity is just theory, then you are wrong. It is applied in the real world. It plays an important role in everyday business, taxation, and planning.

1. Helps Businesses Set Prices

It helps businesses decide the right price for their products.

• If a product is inelastic (e.g., petrol), it can raise the price and still maintain sales.
   
• For elastic goods (e.g., chocolates), a price increase may reduce demand drastically.

2. Supports Government Taxation Policies

Usually, inelastic goods are targeted for taxes (like petrol and cigarettes), since consumers do not cut down usage quickly. It ensures steady tax income.
 

From the above-mentioned table, you can see the impact of goods and taxes.

3. Resource Allocation and Production Planning

You might know that elasticity helps producers understand the goods they need to focus on. 

• If a product shows elastic demand, they may cut down supply during price hikes.
   
• On the other hand, if supply is elastic, producers can react quickly to price signals.

4. Income Growth and Market Forecasting

Most of us know that as income increases, demand for certain goods rises. Retailers and marketers are able to plan better by observing income elasticity. Also, by predicting which goods will see a surge in demand.

5. Understanding Consumer Behaviour

It gives insights into how consumers react to changes in price, income, or competitor pricing.

Real-Life Applications Of Elasticity

The following are the real-world examples of elasticity:

• Electricity is inelastic in the short term. We cannot stop using it even if prices rise.
   
• Luxury cars are highly income elastic. Their sales rise significantly when our income levels increase.
   
• Coffee and tea are substitutes. If one becomes expensive, then we switch to the other.

Final Thoughts

Elasticity makes it easy for you to understand how markets function. You can learn how people respond when prices or incomes change. It helps businesses, sellers, and governments make informed choices.

Whether it's adjusting prices, planning supply, or setting taxes, if you know how elastic or inelastic a product is, it can help you make smarter decisions. 

If you have an understanding of the elasticity concept, then navigating the changing economy and planning better will become easier for you.

FAQs

1. Are all necessities inelastic?

Most are, especially in the short term, like salt and milk.

2. What does it mean if PES is high?

Supply can easily increase with rising prices.

3. Why do governments tax inelastic goods?

They ensure steady revenue despite price hikes.

4. Which goods are usually income elastic?

Luxury goods like high-end electronics and cars.
 

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