2.4 Elasticity

Elasticity is a key concept in microeconomics that measures the responsiveness of one variable to changes in another variable. It provides insight into how changes in price affect the quantity demanded, or supplied, of a good or service. Understanding elasticity helps businesses and policymakers to predict consumer behaviour, set pricing strategies, and evaluate the potential impacts of taxes and subsidies.

This is one of the most common types of elasticity. PED measures the responsiveness of quantity demanded to a change in the price of a good or service. It is calculated as the percentage change in quantity demanded divided by the percentage change in price.

If the absolute value of the PED is greater than 1, demand is considered elastic, meaning consumers are highly responsive to price changes. Conversely, if it is less than 1, demand is inelastic, indicating that consumers are less responsive.

In the diagram above, the left diagram shows a decrease in quantity by 50% and price increases by 20%. The PED is:

\(\text{PED}={50\%}\div{20\%}=2.5\)

With an absolute value greater than 1, demand is elastic.

In the right diagram, quantity decreases from 80 to 72 (10% decrease) and an increase in price from 10 to 14 (40% increase). The PED calculation is:

\(\text{PED}={10\%}\div{40\%}=0.25\)

Since the absolute value is less than 1, demand is inelastic.

In the PED calculation, the signs (negative or positive) represent the direction of the change, negative for a decrease and positive for an increase. However, when calculating PED, we only focus on the absolute value of the result, which disregards the signs. This is because PED is about the magnitude of the response, not the direction.