Reviewed by Aug 27, 2020| Updated on
In economics, elasticity is the calculation of an economic variable's proportional change in response to a change in another. It demonstrates how easy it is for both supplier and customer to adjust their behaviour and replace another product, the power of an incentive over choices against the relative cost of opportunity.
In economic theory, elasticity is one of the essential principles. It is useful in understanding the occurrence of indirect taxation, marginal principles relevant to the firm's theory, and distribution of resources and different types of products as they relate to consumer choice theory. Also, elasticity is crucial in any discussion of welfare distribution, particularly consumer surplus, producer surplus or government surplus.
How Does It Work?
Elasticity can be quantified as the ratio of change in percentage in one variable with respect to change in percentage in another variable if the latter variable has a causal effect on the former. In terms of the differential calculus, more precise description is given. It is a method for evaluating one variable's sensitivity to changes in another causative variable.
The advantage of elasticity is that it is a unitless measure, regardless of the form of quantities being varied. The elasticities often used include price elasticity of demand, price elasticity of supply, income elasticity of demand, the elasticity of substitution between production factors, and intertemporal substitution elasticity.
Application of Elasticity
The principle of elasticity has an extraordinarily broad scope of economic applications. In particular, an understanding of elasticity is essential in understanding a market's response to supply and demand.
Some rising elasticity uses include the impact of price adjustments on client sales.
Tax burden incidence study and other policy policies.
Income elasticity of demand used as a measure of safety for the sector, future trends of consumption, and as a guide to investment decisions for businesses.
The benefit of foreign trade and trade impact words.
Consumption research and behaviour saving.
Analysis of the ads for individual products on customer demand.