4 Eylül 2012 Salı

What is Elasticity? Price Elasticity of Demand, Cross Elasticity, Income Elasticity

In this article, we will try to clarify what Elasticity is. Elasticity, theoretically; is the ratio of the percent change in one variable to the percent change in another variable.  This means that, the ratio of the proportionate change in one variable with respect to a proportional change in another variable, such as the responsiveness of the price of a commodity to changes in market demand or visa-versa. In terms of elasticity, a market or a good can be described as elastic or inelastic related to its responsiveness to the proportionate change in another quantity.

Price elasticity of demand is the measure of responsiveness of the consumers to a price change.  This tool calculates how much the quantity demanded of a product changes as the price changes. The formula of this tool is depicted as follows:

If the demand is elastic it means that the total percentage change in the demand is more than the percentage change in the price. This will result a value which is more than 1. Furthermore, if the opposite happens with a result lower than 1, it means that the price is inelastic.

The following table also shows the elasticity values with the examples given next to each item.

Elasticity Intervals

n = 0
Perfectly inelastic.
No real example. This is an utopic situation. But fundamentals such as bread and water can be very near to here.
0 < n < 1
Relatively inelastic.
Clothes, vegetables
n = 1
Unitary elastic.
1 < n < ∞
Relatively elastic.
Luxury goods, restaurant prices etc.
n = ∞
Perfectly elastic
No real example, but very luxury goods such as private airplanes are near to here.
Cross elasticity of demand is the measure of the responsiveness of the consumers for a good according to a change in the price of another good. It is measured as the percentage change in quantity demanded for the first good that occurs in response to a percentage change in price of the second good. The formula is shown in the following equation:

For example, if, in response to a 10% increase in the price of fuel, the quantity of new cars that are fuel inefficient demanded decreased by 20%, the cross elasticity of demand would be -20%/10% = -2.

Income elasticity of demand is a measure of the change in the demand of a good when there is a change in the income of the consumers. The formula is depicted in the following:

Most of the goods will be demanded more when there is an increase in the income. Nevertheless, there are some goods which are called inferior goods which have negative income elasticities. Inexpensive foods like bologna, hamburger, mass-market beer, frozen dinners, and canned goods are additional examples of inferior goods. As incomes rise, one tends to purchase more expensive, appealing and nutritious foods. Therefore, the foreign travels are quite income elastic. As the income of the people increases, they tend to demand more foreign country travels.

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