## Elasticity

Elasticity is a measure of how sensitive demand is to a change in something that affects it.

You can think of the relationship in terms of the ** dependent** and the

**value.**

*independent*The **DEMAND** for a product is the ** dependent** variable, as it is the variable being influenced. It can be influenced by a number of different or

**variables such as:**

*independent*- Price
- Income
- Advertising
- The prices of other substitute or complementary goods

The ** dependent variable** (the factor being influenced)

**- in this case, demand -**is always placed on the top of the equation as it is being influenced and the

**(the factor causing the change in demand) is placed on the bottom of the equation.**

*independent variable*We will be start by looking at ** price** elasticity of demand with a definition:

### Price elasticity of demand

Price elasticity of demand is a measure of the sensitivity of the demand for a product to changes in *its own price*. In other words, it is a measure of how much demand for a good or service responds to a change in its price.

Price elasticity of demand is calculated and defined as:

The following 'aide memoire' may be of use. You usually put your dinner (demand) on your plate (price). Demand is over price, D over P!

Price and demand are usually in ** inverse relationship**. In other words, as price falls, demand increases; and as price increases, demand falls. The result of any calculation of price elasticity normally results in a

**elasticity. In practice, the negative sign is usually excluded.**

*negative*The value of the elasticity ranges from zero to infinity, and is given different names over different numerical ranges. The table below gives all these possibilities.

Value | Description | Explanation |
---|---|---|

O | PERFECTLY INELASTIC | Price has no effect on demand at all |

Under 1 | INELASTIC | Price has a small effect on demand. The % change in price is larger than the % change in demand |

Exactly 1 | UNITARY | % Change in price and % change in demand are the same. Remember, though, the signs are different. |

Over 1 | ELASTIC | Demand is very sensitive to price. The % change in price is less than the % change in demand. |

Infinity | PERFECTLY ELASTIC | Any increase in price kills demand. |

It is usual to represent the degree of elasticity graphically. The common shapes for demand curves and their elasticity values are given in the diagrams below.

The special shape that represents a price elasticity of 1 is known as a rectangular hyperbola! This is shown below.

Price elasticity of a good or service depends on a range of factors:

- The number of
**close substitutes**in the market. The more substitutes available the greater the elasticity. - Is the product a
**luxury or a necessity**? Luxuries are more elastic than necessities. -
**Amount of income**spent on the product. Cheap items tend to be inelastic. - Is the product
**habit forming**? If so demand will become price inelastic. **The stage of the product life cycle.**

You **will** be expected to:

- calculate elasticity.
- interpret elasticities.
- explain the relationship between elasticities and the product life cycle.
- analyse the relationship between elasticity and sales revenue.