*Elasticity*measures the change in supply, in the case of supply elasticity, or demand, in the case of demand elasticity, as the price changes. From its involvement in creating recessions, use in policy decisions, and forecasting future consumption, this simple concept can show us a great deal about the working of markets.

**Elasticity of Demand**

Above is the general equation for elasticity; for the elasticity of demand replace each "quantity" with "quantity demanded." The elasticity of demand equation is meant to measure the change in consumer's purchasing habits as the price changes. Demand is said to be elastic if quantity demanded responds strongly to a changing price, or inelastic if quantity demanded responds little to a changing price |

Let's examine elasticity of demand in reference to a simple demand curve fitting the equation QD=400-3.5P. Specifically, let's look at what happens when the price, P, moves from 20 to 30, 40 to 30, and 30 to 20. This will allow us to get a good picture of how demand elasticity may change in different circumstances.

First, let's compute the elasticity of demand when P increases from 20 to 30.

400-3.5(20)=330

*First, we find the quantity demanded at the initial price of 20*

400-3.5(30)=295 and the quantity demanded at the new price of 30.

400-3.5(30)=295 and the quantity demanded at the new price of 30.

(330-295)/295 = 0.12

*Next, we find the numerator of the first equation by dividing*

"difference in quantity demanded" into "quantity demanded;" about 0.12.

"difference in quantity demanded" into "quantity demanded;" about 0.12.

(30-20)/20=1/2

*Then, we find the denominator by dividing the "difference in price" by*

"price."

"price."

0.12/(1/2)= 0.06

*Finally, we divided the numerator into the denominator to obtain*

the demand elasticity of about 0.06.

the demand elasticity of about 0.06.

So, the demand elasticity when the price changes from 20 to 30 is about 0.06. We'll look at what this means, but first let's calculate the elasticity for the other price moves. Next up is the move from 40 to 30.

400-3.5(40)=260

*First, we find the quantity demanded at the initial price of 20*

400-3.5(30)=295 and the quantity demanded at the new price of 30.

400-3.5(30)=295 and the quantity demanded at the new price of 30.

(260-295)/295 = -0.12

*Next, we find the numerator of the first equation by dividing*

"difference in quantity demanded" into "quantity demanded;" about -0.12

"difference in quantity demanded" into "quantity demanded;" about -0.12

(40-30)/30=1/3

*Then, we find the denominator by dividing the "difference in price" by*

"price."

"price."

-0.12/(1/3)= -0.36

*Finally, we divided the numerator into the denominator to obtain*

the demand elasticity of about -0.36.

the demand elasticity of about -0.36.

*So, the demand elasticity when the price changes from 40 to 30 is about -0.36. Let's finish up by finding the from 30 to 20.*

400-3.5(20)=330

*First, we find the quantity demanded at the initial price of 20*

400-3.5(30)=295 and the quantity demanded at the new price of 30.

400-3.5(30)=295 and the quantity demanded at the new price of 30.

(330-295)/330 = 0.11

*Next, we find the numerator of the first equation by dividing*

"difference in quantity demanded" into "quantity demanded;" about -0.11

"difference in quantity demanded" into "quantity demanded;" about -0.11

(20-30)/30=-1/3

*Then, we find the denominator by dividing the "difference in price" by*

"price."

"price."

0.11/(-1/3)= -1/3

*Finally, we divided the numerator into the denominator to obtain*

the demand elasticity of about -1/3.

the demand elasticity of about -1/3.

So, the demand elasticity when the price changes from 30 to 20 is about -1/3. I'm sure you've noticed that these 3 elasticities, all for the same demand curve. Many struggle to understand this concept intuitively. Shouldn't elasticity be constant over a demand curve; especially one described by something is simple as a line? This question trips up many students when they azthire first introduced to the concept of elasticity.

In fact, elasticity can change for different price changes along the same demand curve. The economic intuition is that a price change from an extreme will effect quantity demanded more than it would from a non-extreme value of P. For instance, quantity demanded should change more for a pack of gum whose price changes from $10 to $9 than it would had the price changed from $2.50 to $1.50. Similarly, the quantity demanded would be expected to change more dramatically had the price changed from $0.05 to $1.05 than it would from $2.50 to $1.50

This can be seen in the results we found. When the price moved from 30 to 20, the quantity demanded was found to be less elastic, which means that quantity demanded was less responsive to price, than it was from 40 to 30. This also explains the differentelasticities for moves from 30 to 20 and 20 to 30, the price started at different levels so the percentage change was different.

Whether good's demand is elastic or inelastic is defined on whether or not the elasticity is more or less than the absolute value of 1. Values of elasticity smaller than the absolute value of 1 are considered inelastic, because a 1% change in price causes less than a 1% change in quantity demanded. Likewise, values of elasticity larger than the absolute value of 1 are considered elastic, because a 1% change in price causes a more than 1% change in quantity demanded. An elasticity of the absolute value 1 is called

*unit elastic*, and represents where a 1% change in price causes an equal change in quantity demanded

Elasticity = 0.4

*inelastic*

Elasticity = -1.3

*elastic*

Elasticity=1

*unit elastic*

**Determinants of Demand Elasticity**

The elasticity of demand for a product is affected by several variables. Some of the most prominent are listed below:

**Availability of Close Substitutes -**If consumers can just switch to a substitute good when the price rises, they will have more elastic demand curves.

**Whether the good is a necessity or luxury -**

**Luxury good have more elastic demand curves than those goods which are necessary for survival. This is related to autonomous consumption, and is caused by the fact that consumers must consume necessities, no matter how expensive they are, while luxury goods are not needed and can be abandoned if they are too expensive. This causes necessities too be inelastic, and luxury goods to be elastic

**

**Magnitude of Price Change -**As was show above, elasticity is different for different prices. Quantity demanded is more responsive to movements of prices from extreme values.