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What is Elasticity in Economics? - Definition, Theory & Formula

What is Elasticity in Economics? - Definition, Theory & Formula
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  • 0:02 Definition of Elasticity
  • 1:12 Income Elasticity of Demand
  • 1:43 Cross and Advertising…
  • 2:18 Interpretation
  • 2:44 Advantages and Disadvantages
  • 3:42 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Francis

Jennifer has a Masters Degree in Business Administration and pursuing a Doctoral degree. She has 14 years of experience as a classroom teacher, and several years in both retail and manufacturing.

In this lesson, we'll discuss elasticity in economics, including its definition, the different types of elasticity, and their effect on the business market. We'll also use a real-life example and learn how to use simple formulas to calculate elasticity of demand.

Definition of Elasticity

In today's economy, doesn't it seem that the less expensive a product, the more people seem to want it? In economics, elasticity is used to determine how changes in product demand and supply relate to changes in consumer income or the producer's price. To calculate this change, we can use the following formula:

Elasticity = % Change in Quantity / % Change in Price


Elasticity


The diagram here shows the changes in price (p) of Mabel's Homemade Candy and the corresponding change in the quantity demanded (q). The red slanting line is called the demand curve. At a price of $1.50, the quantity demanded is three units. When the price is lowered to $0.50, the quantity in demand increased to five units. Ms. Mabel can then make the assumption that every increase in price will result in fewer purchases of her candy.

Income Elasticity of Demand

Income elasticity of demand is a measure of the responsiveness of the demand for a particular good or service, as a result of a change in income of the target market or ceteris paribus. Ceteris paribus is a Latin phrase used in economics, meaning 'with all other factors held constant'. To calculate this change, we use a different formula:

Income Elasticity of Demand = % change in quantity demanded / % change in income

Interpretation

There are three basic ways that the result of an elasticity calculation may be interpreted:

  • Inelastic: The result is less than 1(< 1), meaning that spending is not very price sensitive
  • Unitary Elasticity: The result is equal to 1 (= 1), meaning when spending changes are proportionate with price changes
  • Elastic: The result is greater than 1 (> 1), meaning that spending is fairly price sensitive

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