What Is Elasticity?
Micro & Behavior · Markets & Competition
In one sentence: Elasticity measures how strongly one economic quantity responds, in percentage terms, when another quantity changes.
The intuition
Knowing that people buy less when the price rises is only half the story. The useful question is how much less. If a 10% price rise barely dents sales, the seller earns more. If it sends customers fleeing, the seller earns less. Elasticity is the number that tells the two situations apart.
The most common version is the price elasticity of demand: the percentage change in quantity demanded divided by the percentage change in price. Because price and quantity move in opposite directions the result is negative, so economists usually quote its absolute value. A value above 1 is called elastic — quantity responds more than proportionally. A value below 1 is inelastic — quantity responds less than proportionally. Exactly 1 is unit elastic.
Using percentages rather than raw units is what makes the measure portable. You can compare the price sensitivity of petrol, measured in litres, with that of cinema tickets, measured in seats, because both are expressed as percentage responses.
What makes demand elastic or inelastic
Four things mostly determine it. Substitutes: the more easily buyers can switch to something else, the more elastic demand is. One brand of bottled water is highly elastic; water itself is not. Necessity: insulin and commuter fuel are inelastic; restaurant meals are elastic. Budget share: people barely notice a 20% rise in the price of salt, but a 20% rise in rent forces a rethink. Time: demand is more elastic in the long run, because people can change habits, cars and homes.
The same logic applies on the supply side. Price elasticity of supply measures how much more producers offer when the price rises. It is low when capacity is fixed — beachfront land, a concert venue tonight — and high when production can be scaled up cheaply.
Why it matters
Elasticity decides who really pays a tax. When a tax is placed on a good, the burden falls mostly on whichever side of the market is less elastic, because that side has fewer ways to escape. That is why taxes on cigarettes and fuel are largely paid by consumers.
It also drives pricing. A firm facing inelastic demand raises revenue by raising its price; a firm facing elastic demand raises revenue by cutting it. Airlines charge business travellers more than tourists for the same seat because their demand is less elastic. And it explains a farming paradox: because food demand is inelastic, a bumper harvest can lower farmers' total income — prices fall by more than quantities rise. Elasticity is the natural next step after supply and demand.
A worked example
A cinema sells 400 tickets a night at $10, so revenue is $4,000. It raises the price to $12 — a 20% increase. Attendance falls to 360, a 10% drop.
The price elasticity of demand is the percentage change in quantity divided by the percentage change in price: −10% ÷ 20% = −0.5. In absolute terms that is 0.5, which is below 1, so demand is inelastic over this range. Revenue confirms it: 360 × $12 = $4,320, up from $4,000.
Now suppose a rival cinema opens across the street. The same price rise to $12 cuts attendance to 280, a 30% drop. Elasticity is −30% ÷ 20% = −1.5 — elastic. Revenue falls to 280 × $12 = $3,360. Nothing about the film or the seats changed; the arrival of a substitute made customers more price sensitive. (Economists often use the midpoint formula so the answer is the same whichever direction the price moves; the simple version is used here for clarity.)
Common misconceptions
- ✗ Elasticity is the same as the slope of the demand curve.✓ Slope uses units; elasticity uses percentages. A straight-line demand curve has a constant slope but a different elasticity at every point.
- ✗ Inelastic demand means quantity does not change at all.✓ It means quantity changes by a smaller percentage than price. Only perfectly inelastic demand — a vertical curve — shows no response.
- ✗ A good is either elastic or inelastic, full stop.✓ Elasticity depends on the price range, the time horizon and how narrowly the good is defined. Petrol is inelastic this week and far more elastic over ten years.
Frequently asked questions
What is the formula for price elasticity of demand?
Price elasticity of demand = % change in quantity demanded ÷ % change in price. Values above 1 in absolute terms are elastic, below 1 inelastic, and exactly 1 unit elastic.
What other kinds of elasticity are there?
Income elasticity measures how demand responds to income (positive for normal goods, negative for inferior goods). Cross-price elasticity measures how demand for one good responds to another good's price (positive for substitutes, negative for complements). Elasticity of supply measures producers' response to price.
How does elasticity affect total revenue?
If demand is elastic, price and revenue move in opposite directions: cutting the price raises revenue. If demand is inelastic they move together: raising the price raises revenue. At unit elasticity revenue is unchanged.
Related concepts
Sources
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