Elasticity is a way to see how much people or businesses change what they buy or sell when things like prices or income change. Imagine you love candy. If candy prices go up, do you stop buying it, or do you still buy a lot? Elasticity helps measure this kind of reaction.
This guide will explain what elasticity means in economic terms, provide the formulas used to calculate it, and walk you through a step-by-step example to use with an elasticity calculator.
Calculator
Formula – How to calculate elasticity
Elasticity (E) = % Change in Quantity ÷ % Change in Price
Where:
- % Change in Quantity refers to how much demand or supply changes. % Change in Quantity = (Quantity End – Quantity Start) ÷ Quantity Start
- % Change in Factor refers to the factor being analyzed, such as price or income. % Change in Price = (Price End – Price Start) ÷ Price Start
How to Calculate Elasticity – step by step
Step 1: Find the change in quantity.
Look at how much people bought before and after the price changed.
Step 2: Find the change in price.
Look at how much the price changed.
Step 3: Plug the numbers into the formula.
Divide the percentage change in quantity by the percentage change in price to find elasticity.
Step-by-Step Example
Let’s say a toy costs $10, and people buy 100 toys. If the price increases to $12 and people buy only 80 toys, the elasticity is:
Step 1: Find the change in quantity.
% Change in Quantity = (New Quantity – Old Quantity) ÷ Old Quantity x 100%
% Change in Quantity = (80 – 100) ÷ 100 x 100% = -20%
Step 2: Find the change in price.
% Change in Price = (New Price – Old Price) ÷ Old Price x 100%
%Change in Price = (12 – 10) ÷ 10 x 100% = 20%
Step 3: Plug the numbers into the calculator or the formula to calculate the elasticity
Elasticity = -20% ÷ 20% = -1
Result: The elasticity is -1. This means that if the price changes by 1%, the quantity people buy changes by 1% in the opposite direction.
Results
An elasticity of -1 means that the product is unit elastic. This means that a 20% rise in price will result in a 20% drop in demand.
An elasticity of more than 1
Definition: What Is “Elasticity” in Economics?
Elasticity is a way to measure how much people change what they do when something changes, like prices or income. For example, if the price of candy goes up and people stop buying it, candy is elastic. But if the price of gas goes up and people still buy just as much of it, gas is inelastic because the amount people buy doesn’t change when the price changes.
If a store knows their product is elastic, they’ll be careful about raising prices because people might stop buying. Governments use elasticity to plan taxes—if something is inelastic, like cigarettes, they know people will still buy even if they put lots of taxes on them, making the price go up.
Elasticity can also look at other things, like how much people buy when they make more money (income elasticity) or how the price of one product affects another (cross-price elasticity).
Elasticity can also be measured in its normal form as arc (midpoint) elasticity.
Price Elasticity of Demand vs. Price Elasticity of Supply
Price elasticity of demand measures how much the quantity demanded changes in response to price changes. Price elasticity of supply measures how much the quantity supplied changes due to price changes. While demand elasticity focuses on consumers, supply elasticity focuses on producers and how easily they can adjust production in response to price shifts.
Elasticity vs. Arc (Midpoint) Elasticity
While elasticity calculates the responsiveness of quantity to changes in price or other factors at a specific point, arc elasticity measures elasticity over a range of prices or quantities. Arc elasticity uses the midpoint formula to provide a more accurate average elasticity between two points, reducing sensitivity to the starting point. This is particularly useful when dealing with larger price changes.
Elasticity vs. Cross-Price Elasticity
Elasticity typically refers to how the quantity demanded or supplied of a good responds to its own price changes. In contrast, cross-price elasticity measures how the quantity demanded of one good responds to a price change in a related good, revealing whether two goods are substitutes (positive value) or complements (negative value).
FAQ
Q: What does it mean if elasticity is greater than 1?
A: It’s elastic, meaning people are very sensitive to price changes. If the price goes a little bit higher, lots of people will stop buying the item. If the price goes a little bit lower, a lot more people will buy the item.
Q: Can elasticity be negative?
A: Yes, especially for price elasticity of demand, because when price goes up, the quantity demanded usually goes down (and vice versa).
Q: What does it mean if elasticity is 0?
A: It means people don’t react at all to price changes. If the price were to double, the item would still sell just as much.
Q: How does elasticity affect revenue?
A: If demand is elastic, raising prices can decrease revenue. If demand is inelastic, raising prices can increase revenue.
Sources and more resources
- Khan Academy. (n.d.-g). https://www.khanacademy.org/economics-finance-domain/microeconomics/elasticity-tutorial
- Wikipedia contributors. (2024f, September 6). Elasticity (economics). Wikipedia. https://en.wikipedia.org/wiki/Elasticity_(economics)
- Dr. Emma Hutchinson, University of Victoria. (2017, November 16). 4.1 Calculating elasticity. Pressbooks. https://pressbooks.bccampus.ca/uvicecon103/chapter/4-2-elasticity/
- Kacapyr, E., & Redelsheimer, J., & Musgrave, F. Barron’s AP Microeconomics / Macroeconomics (6th ed.). (2018). United States of America: Barron’s. ISBN: 978-1-4380-1065-6. Page 65.
- Pindyck, R., & Rubinfeld, D., Microeconomics (8th ed.), (2013). United States of America: Pearson. ISBN 13: 978-0-13-285712-3. Page 33.
- Nicholson, W., & Snyder, C. Microeconomic Theory – Basic Principles and Extensions (10th ed.). (2008). United States of America: Thomas South-Western. ISBN 13: 978-0-324-42162-0. Page 26.
- Greenlaw, S., & Shapiro, D., Principles of Microeconomics 2e. (2018). Houston: Rice University OpenStax. ISBN 13: 978-1-947172-35-7. Page 107.