Elasticity is a concept which compares how sensitive one variable is to changes in another. Usually variables are demand or supply, the reaction of these variables to the changes in price or income is measured.
In the economic field elasticity stands for demand and supply changes as a reaction to price or income changes. Mostly it’s used in consumer demand to assess changes in it as a response to price changing.
Main principles of Elasticity
There are many changes in the value of elasticity, in case the value is higher than 1.0, it means that the demand is more than proportionally under the influence of price movement. Otherwise, in case this value is under 1.0, it means that the demand isn’t too sensitive about price, thus, it’s inelastic. The term inelastic refers to a situation in which a customer buys products with the same frequency when price is increasing and even in case the price is decreasing a customer retains the level of frequency.
In case elasticity equals zero, then it’s regarded as “perfectly” inelastic, thiы situation refers to a situation in which the demand will be the same no matter what price a product will have. However, this is a rare case, and the world has hardly ever seen it. In case it existed, a producer would sell their products at a price they want and customers would have no choice but buy these products. Such a product is air, that’s why it's perfect that no one is able to be totally in charge of it.
In case the demand for a product is changing more than proportionally under rising and falling prices, then this product may be called elastic. On the contrary, in case the demand for a product remains steady under the price movements, this product can be regarded as inelastic.
There are several inelastic products, such as petrol, Apples, tap water, etc. No matter how much the price will rise, the level of demand remains the same as people can’t cease to buy these products. Petrol doesn’t have many alternatives since car owners aren’t able to give it up. Apple is a widely known and famous brand, thus, numerous people buy its devices despite the increasing price. Tap water, in its turn, is a necessity as well since it surely has alternatives, but the service is highly comfortable, that’s why it’s difficult to refuse to use it. For this reason tap water is under government control.
On the other hand, there are elastic products, which are soft drinks, cereals, clothing, cars, etc. Generally, elastic products either aren’t necessities or have many other alternatives, that’s why when increasing price consumers either cease to buy it or search for a similar product with adequate price.
Elasticity of demand. There are several factors that affect the quantity demanded. It’s income, preferences, price. Every time the factors change, it brings about changes in the goods quantity demanded as well. There is also the measure called price elasticity of demand, which reflects changes in the quantity demanded that happened because of price movements.
Income Elasticity. This kind means the changes happening in the quantity demanded for a particular product because of the real income of a regular customer has also changed. In order to calculate income elasticity demand you need to divide the percent change in quantity demanded by the percentage change in income. This measure is used to distinguish necessity and luxury goods.
Cross Elasticity. This concept is also known as a cross-price elasticity of demand, it estimates the quality of reacting in the quantity demanded of a one product under conditions in which the price of another product moves. You may calculate very easily, divide the percentage change in the quantity demanded of one product by the percentage change in the price of the other product.
Price Elasticity of supply. This measure estimates the quality of reacting to the supply of a product as soon as its market price moves. The theory says at the time the price increases the supply of a product increases as well. The same mechanism with decreasing price, at the moment the price falls, the supply of a product falls as well.
What influences on demand Elasticity
Among all factors that influence demand elasticity there are three distinguished ones:
Availability of Substitutes. As a rule, if there are many substitute goods, the demand is rather more elastic. Substitute goods are products that can be used instead of another similar product. The most famous example of substitute goods is butter and margarine. If butter’s price is increasing, people who use butter for cooking and baking may replace it with a cheaper margarine.
Another example is lattes and cappuccinos. Both of them are made of espresso and steamed milk, that’s why they can be easily replaced. At the same time, there are few substitute goods for caffeine. Moreover, not all people are ready to meet mornings without a dose of energy, thus, caffeine may be regarded as an inelastic good. That’s why a particular good may be replaced with a similar one and called elastic, while the industry itself is prone to be inelastic.
Necessity. As it was mentioned in the above paragraphs, in case people need a good for comfort or survival, it will be bought no matter how high the price is. For example, people with diabetes aren’t able to maintain life on a decent level without insulin, it's a life-saving medication, thus, even if the price goes higher, the demand for it won’t fall.
Time. If we take the caffeine example and look at it from the other side, we may figure out how time affects it. For example, a person takes a cup of americano every morning, even if the price rises, this person isn’t able to resist the desire to satisfy himself or herself and buys coffee no matter what, in this case caffeine price is inelastic. Nevertheless, in case this person decides to give up coffee since the caffeine price significantly has increased, eventually the price becomes elastic.
How elasticity helps in business
Awareness of elasticity of a good or service may be exceedingly useful for business and specifically for companies since those with high elasticity may be naturally involved in the price competition and in order to stay solvent companies should have high sales volume. At the same time, companies that are inelastic may enjoy the opportunity of setting prices as high as they can.
The elasticity influences not only on prices, but on customer retention rates as well. Companies usually tend to sell products with inelastic demand in order to keep their customers and maintain their interest in the company’s production. Thus, even if the price increases, customers still prefer a particular company to others.
There is a remarkable example of elasticity, which occurred during the COVID-19 outbreak. Normally, the gas industry is inelastic. However, during the earliest stages of the pandemic, especially during March and April global demand for oil dramatically fell with rising supply and lack of storage space.