Elasticity of supply and demand is a measurement of quantity sensitivity to price changes. Elasticity explains change in quantity supplied or demanded as a result of a price change. Another way to think of elasticity is the supply and demand curves' slope. There are elastic (gradual slope) and inelastic (steep slope) curves. An elastic curve is when a small change in price creates a large change in quantity. The supply curve drawn below goes up in price by $10, but increases in quantity by 20. It is an elastic curve because its percent change in quantity is greater than its percent change in price. The demand curve, as illustrated below, is an inelastic curve. With the exact same change in price, there is only a small change in quantity demanded. The percent change in quantity demanded is smaller than the percent change in price.
Factors that effect elasticity of supply:
- Marginal Production- If it is difficult to increase production of a good then the curve is inelastic and if it is easy to produce more then the curve is more elastic. Hand-made antiques would be an example of a more inelastic good in comparison to toothpicks made quickly through machines.
- Source of Supply- If a good is already maximizing the global supply of resources then it is very inelastic, where as a product using only a small portion of raw materials can increase production and is more elastic.
- Time Horizon- Over a short period of time, supply curves are more inelastic as it must produce goods with existing capital and infrastructure. In a long run market scenario, companies can expand their production and the product becomes more elastic.
Factors that effect elasticity of demand:
- Substitutes- The fewer substitutes that exist to replace a good, the more inelastic the demand curve. If there are more options and goods to choose from, the curve is elastic.
- Scope of Product- The demand for an entire category of a product such as blue jeans is more inelastic than the market for designer blue jeans.
- Necessities vs. Luxuries- The demand for life essentials is significantly more inelastic than the demand for life's luxuries.
- Size of Budget- For those items that are a small part of your budget, your demand for them is largely more inelastic than purchases that consume more of your income.
Elasticity of demand has a very useful application to business. It helps determine total revenues and prices. Total revenues= Price x Quantity. If a business is aware of their good having inelastic demand, they know they can charge a higher price and only lose a few buyers and increase their net revenues. The opposite is true for a businessman with elastic buyers. Other important applications to elasticities will be unpacked in my explanations of taxes and subsidies.
