Elastic

Definition

In economics, elastic refers to the sensitivity of quantity demanded or supplied to changes in price. When demand or supply is elastic, a small change in price leads to a significant change in the quantity demanded or supplied. This concept is crucial for understanding consumer behavior and market dynamics, as it highlights how price changes can dramatically affect purchasing decisions and overall market equilibrium.

5 Must Know Facts For Your Next Test

1. Elasticity is measured using the price elasticity coefficient, which is calculated by dividing the percentage change in quantity demanded by the percentage change in price.
2. If the price elasticity coefficient is greater than 1, demand or supply is considered elastic; if it is less than 1, it is inelastic; and if it equals 1, it is unit elastic.
3. Goods that are considered luxuries tend to have more elastic demand, while necessities usually exhibit more inelastic demand.
4. The availability of substitutes significantly impacts elasticity; more substitutes lead to greater elasticity as consumers can easily switch between products.
5. Understanding elasticity helps businesses set prices strategically and predict how changes in price will affect their sales revenue.

Review Questions

• How does the concept of elasticity help explain consumer behavior in response to price changes?
  • Elasticity provides insight into how consumers adjust their purchasing decisions based on price changes. When demand for a product is elastic, a small increase in price may lead to a large decrease in quantity demanded, indicating that consumers are sensitive to price fluctuations. This understanding allows businesses to anticipate shifts in consumer behavior and adjust pricing strategies accordingly.
• Discuss the relationship between elasticity and total revenue, using examples of both elastic and inelastic goods.
  • The relationship between elasticity and total revenue is crucial for understanding pricing strategies. For elastic goods, an increase in price often results in a decrease in total revenue since the loss in sales outweighs any gains from higher prices. Conversely, for inelastic goods, raising prices can increase total revenue because the quantity demanded does not significantly decline. For instance, if a luxury item has an elastic demand and its price increases, total revenue may drop due to reduced sales. In contrast, a necessary medication with inelastic demand can have its price increased without significantly affecting total revenue.
• Evaluate the implications of elasticity on market structure and competition among firms within an industry.
  • The implications of elasticity on market structure are significant as they influence competitive strategies among firms. In industries where products have elastic demand, companies must be cautious about pricing; they may engage in competitive pricing strategies or offer promotions to retain customers. On the other hand, firms selling goods with inelastic demand have more pricing power since consumers will continue buying regardless of small price increases. This dynamic can shape market structures, as firms producing essential goods may dominate due to their pricing power while those producing luxury items must compete aggressively for market share.

Related terms

Inelastic: A situation where the quantity demanded or supplied is not very responsive to price changes, meaning a change in price leads to a relatively smaller change in quantity.

Unit Elastic: A scenario where the percentage change in quantity demanded or supplied is exactly equal to the percentage change in price, resulting in no revenue change.

Price Elasticity of Demand: A measure that calculates the responsiveness of the quantity demanded of a good to a change in its price, typically expressed as a percentage.