Price Elasticity of Demand Explained
Elasticity is an economic concept introduced by the English economist Alfred Marshall, from physics, to quantify the variation (which may be positive or negative) experienced by one variable in changing another. To understand the economic concept of elasticity we must start with the existence of two variables, among which there is a certain dependence, for example the number of cars sold and the price of automobiles, or gross domestic product and interest rates. The elasticity measures the sensitivity of the number of cars sold in the face of price changes, or in the second case the sensitivity of GDP to changes in interest rates.
This is why elasticity can be understood or defined as the percentage change of a variable X in relation to a variable Y. If the percentage variation of the dependent variable Y is greater than the independent variable X, it is said that the relation is elastic , Since the dependent variable Y varies in greater quantity of the variable X. In contrast, if the percentage variation of the variable X is greater than Y, the relation is inelastic.
Elasticity is one of the most important concepts used in economic theory. It is used in the study of the demand and the different types of goods that exist in the theory of the consumer, the incidence of indirect taxation, the marginal concepts in the theory of the company, and the distribution of wealth. Elasticity is also important in the analysis of welfare distribution, in particular, consumer surplus and producer surplus.
Demand-price elasticity or simply elasticity of demand measures the relative or percentage change in quantity demanded as a consequence of a price change of one percent, in other words, it measures the intensity with which buyers respond to A variation in price.
Scope of the concept
Elasticity is often used with respect to the price-demand and price-supply relationship, but the applicability of this concept is not restricted to that single case, but is broader, since the elasticity is calculated with percentages due Which is the only way to obtain a common unit of measure. When calculating elasticity in a relation, the units of measurement are maintained, therefore, it does not measure a proportional change, but a propensity, such as the propensity for Keynesian consumption.
Price elasticity of demand
In a market economy, if the price of a product or service rises, the quantity demanded of it will fall, and if the price of that product or service falls, the quantity demanded will rise. Elasticity informs the extent to which the demand for price changes is affected, so there may be products or services for which the price rise produces a small variation in the quantity demanded, this means that consumers will buy the same Quantity, regardless of price variations, the demand for this product is an inelastic demand. The reverse process is when small variations in price greatly modify the amount demanded and then the demand for that product is said to be elastic.
For example, bread has been a typically inelastic product in Western culture, since it is considered a staple commodity, so that, although the price of the same rose dramatically, demand would not be modified to the same extent (double The price of the loaf does not cause demand to fall in half), while lowering its price would not increase demand (that the loaf of bread will lower its price in half will not cause us to consume twice the bread ).
Knowing if we are faced with a product of high or low elasticity is very important when making decisions regarding prices. If we are faced with a product with an inelastic demand, we know that we have a wide margin of price increase, and that a price decrease would not serve anything, since there would be no significant variations in demand. If we are faced with a product with elastic demand, we know that a fall in prices will trigger demand, and therefore give better overall results, while a rise in prices can lead to a sudden drop in sales.
Main factors that may influence price elasticity of demand
- The existence of reciprocal substitute goods, to a greater or lesser extent.
- The proportion of the consumer’s income devoted to the expenditure of the object under analysis.
- The complementary character of some goods in relation to others more expensive or cheaper.
- The greater or lesser durability of the object under analysis (perishability).
- The extent of the exercise considered in the analysis.
- The tastes and preferences of the consumer.
This is merely an overview of the subject and does not delve into the actual mathematics of elasticity; however, hopefully, we have provided you with a good framework from which to start. For a graphic representation of elasticity, check out Investopedia’s video here.