Elasticity vs. Inelasticity of Demand: An Overview
Inelasticity and elasticity of demand refer to the degree to which demand responds to a change in another economic factor, such as price, income level, or substitute availability. Elasticity measures how demand shifts when other economic factors change. When fluctuating demand is unrelated to an economic factor, it is called inelasticity.
Elastic demand means there is a substantial change in quantity demanded when another economic factor changes (typically the price of the good or service), whereas inelastic demand means that there is only a slight (or no change) in quantity demanded of the good or service when another economic factor is changed.
The elasticity of demand is an important economic concept. This article will explore more about the concepts of elasticity and demand, and the difference between demand that is elastic and demand that is considered inelastic.
- Elasticity of demand refers to the degree in the change in demand when there is a change in another economic factor, such as price or income.
- If demand for a good or service remains unchanged even when the price changes, demand is said to be inelastic.
- Examples of elastic goods include luxury items and certain food and beverages.
- Inelastic goods, meanwhile, consist of items such as tobacco and prescription drugs.
- The elasticity of demand is calculated by dividing the percentage change in the quantity demanded by the percentage change in the other economic variable.
What Is Elasticity?
Elasticity of Demand
The elasticity of demand, or demand elasticity, refers to how sensitive demand for a good is compared to changes in other economic factors, such as price or income. It is commonly referred to as price elasticity of demand because the price of a good or service is the most common economic factor used to measure it.
The elasticity of demand helps companies predict changes in demand based on a number of different factors, including changes in price and the market entry of competitive goods.
An elastic good is defined as one where a change in price leads to a significant shift in demand. In general, the more substitutes there are for an item, the more elastic demand for it will be.
The elasticity of demand for a given good or service is calculated by dividing the percentage change in quantity demanded by the percentage change in price. If the elasticity quotient is greater than or equal to one, the demand is considered to be elastic. While the price of a good or service is the most common economic factor used to measure the elasticity of demand, there are other measures of the elasticity of demand, including income elasticity of demand and substitute elasticity of demand.
Demand is sometimes plotted on a graph: A demand curve shows how the quantity demanded responds to price changes. The flatter the curve, the more elastic demand is.
Price Elasticity of Demand
The elasticity of demand is commonly referred to as price elasticity of demand because the price of a good or service is the most common economic factor used to measure it.
For example, a change in the price of a luxury car can cause a change in the quantity demanded. If a luxury car producer has a surplus of cars, they may reduce their price in an attempt to increase demand. The extent of the price change will determine whether or not the demand for the good changes and if so, by how much.
Price elasticity of demand is calculated by taking the proportional change of the amount purchased (in response to a small change in price), divided by the proportional change of price.
Income Elasticity of Demand
The income elasticity of demand is also known as the income effect. The income level of a given population can influence the demand elasticity of goods and services.
For example, suppose that an economic event leads to many workers being laid off. During this time period, people may decide to save their money rather than upgrading their smartphones or buying designer purses. This would lead to luxury items becoming more elastic. In other words, a slight change in income level would lead to a significant change in the consumption of luxury goods.
Substitute Elasticity of Demand
If there is an easy substitute for a good or service, the substitute makes the demand for the good more elastic. The presence of an alternative good or service makes the original good or service more sensitive overall to price changes.
For example, if the price of Android phones increases by 10%, this could cause consumers to demand less Android phones. As a result, an increase in demand for iPhones leads to more demand for iPhones. Because iPhone smartphones are a close substitute in quality and price, consumer demand for them will rise.
Examples of Elastic Products
Common examples of elastic products are consumer discretionaries, such as a brand of cereal. Certain food products are not a necessity. For instance, it’s reasonable to argue that people would stop buying a particular brand of cereal if its price shot up dramatically, particularly if other comparable products didn’t follow suit and kept their prices the same.
Conversely, if this same brand of cereals experienced a steep price cut, we’d expect more people to buy it, assuming its level of quality is similar to peers and we aren't in a deep recession.
Another example of an elastic product is a Porsche sports car. Because a Porsche is typically such a large portion of someone's income, if the price of a Porsche increases in price, demand will likely be elastic. There are also alternatives, such as Jaguar or Aston Martin.
Similarly, if the price of a Kit-Kat chocolate bar increases, people will buy a different type of candy bar.
Heinz ketchup usually sells at wholesale prices that are about 10% higher than Hunt’s or Del Monte’s and as much as 20% over private labels. Richard B. Patton, president of Heinz U.S.A., makers of Heinz Ketchup, claims that his company's continued success in the ketchup category is the result of extensive advertising, which has allowed his brand to sell their product for more than its competitors.
Inelasticity of Demand
An inelastic product, on the other hand, is defined as one where a change in price does not significantly impact demand for that product.
Should demand for a good or service be static when its price or other factor changes, it is said to be inelastic. In other words, when the price changes or consumer's incomes change, they will not change their buying habits.
Inelastic products are necessities and, usually, do not have substitutes they can easily be replaced with.
Since the quantity demanded is the same regardless of the price, the demand curve for a perfectly inelastic good is graphed out as a vertical line.
For businesses, there are many advantages to price inelasticity. For example, they have greater flexibility with prices because demand remains basically the same, even if prices increase or decrease. If the business raises its prices up or down, consumers' buying habits will remain mostly unchanged. This can impact demand and total revenue for a business in a couple of different ways.
First, a business may have less overall revenue. If the price for an inelastic good is decreased and the demand for that good does not increase, this would result in a decrease in revenue. For this firm, there is no beneficial outcome in reducing the price of its goods.
Second, a business may experience more overall revenue. If the price for an inelastic good is increased and the demand for that good stays the same, the total revenue will increase because the quantity demanded has not changed. Normally, a price increase does, in fact, lead to a decrease in quantity demanded (even if it is small). So, businesses that deal with inelastic goods are generally able to increase their prices, sell a little less, and still make higher revenues.
They tend to be protected against economic downturns and better able to maximize profits.
Examples of Inelastic Products
The most common goods with inelastic demand are utilities, prescription drugs, and tobacco products. In general, necessities and medical treatments tend to be inelastic, while luxury goods tend to be the most elastic.
Another typical example is salt. The human body requires a specific amount of salt per pound of body weight. Too much or too little salt could cause illness or even death, so the demand for it changes very little when price changes—salt has an elasticity quotient that is close to zero and a steep slope on a graph.
While there are no perfectly inelastic goods, there are some goods that come pretty close. For example, people need gas to drive their cars. Even if gas prices get higher, people may not be able to stop commuting to work, taking their kids to school, and driving to the store. Thus, people will still purchase gas even at a higher price.
Cross Elasticity of Demand
The cross elasticity of demand measures the responsiveness in the quantity demanded of one good when the price for another good changes. Cross elasticity of demand can refer to substitute goods or complementary goods. When the price of one good increases, the demand for a substitute good will increase as consumers seek a substitute for the more expensive item. Conversely, when the price for a good increases, any items closely associated with it and necessary for its consumption (referred to as complementary goods) will also decrease.
Advertising Elasticity of Demand
The advertising elasticity of demand (AED) is a measure of a market's sensitivity to increases or decreases in advertising saturation. The elasticity of an advertising campaign is measured by its ability to generate new sales.
Positive advertising elasticity means that an uptick in advertising leads to an increase in demand for the goods or services advertised. A good advertising campaign will lead to a positive shift in demand for a good.
What Is the Best Definition of Elasticity?
In general, elasticity is a measure of a variable's sensitivity to a change in a different variable. Most often, elasticity refers to the change in demand when the price for a good or service changes.
What Are the 4 Types of Elasticity?
The four main types of elasticity of demand are price elasticity of demand, cross elasticity of demand, income elasticity of demand, and advertising elasticity of demand.
- Price elasticity of demand is a calculation that measures the ratio of the percentage change in the amount demanded of a good or service to a percentage change in its price.
- Cross elasticity of demand measures the percentage change in the quantity demanded of a good to the percentage change in the price of a related good.
- Income elasticity of demand expresses the change in a consumer’s demand for any good to the change in their income. It can be expressed as the ratio of the percentage change in the quantity demanded of a good or service to the percentage change in income.
- Advertising elasticity of demand measures the expected changes in demand as a result of a change in other promotional expenses. A good advertising campaign will result in an increase in advertising expenditures for a company and an increase in demand for the advertised good or service.
How Is Elasticity Measured?
Elasticity is measured by the ratio of two percentages. For example, consider the price elasticity of demand. The price elasticity of demand is measured by calculating the ratio of the change in the quantity demanded to the change in the price. In other words, price elasticity is the ratio of a relative change in quantity demanded to a relative change in price.
What Does a Price Elasticity of 1.5 Mean?
If the price elasticity is equal to 1.5, it means that the quantity demanded for a product has increased 15% in response to a 10% reduction in price (15% / 10% = 1.5).
What Is an Example of Elasticity?
In the most basic sense, elasticity is a measure of a variable's sensitivity to a change in another variable. Most commonly, elasticity refers to an economic gauge that measures the change in the quantity demanded for a good or service in relation to price movements of that good or service. For example, when demand is elastic, its price has a huge impact on its demand.
Housing is an example of a good with elastic demand. Because there are so many options for housing—house, apartment, condo, roommates, live with family, etc.—consumers do not have to pay one price for housing. If one type of housing cost becomes really expensive, or housing in a particular region becomes really expensive, many people will opt for a different type of housing rather than paying the higher price. In this way, the variable of housing is very sensitive to changes in price.
The Bottom Line
With elastic demand, demand changes more than the other variable (most often price), whereas with inelastic demand, demand does not change even when another economic variable changes. Products and services for which consumers have many options most often have elastic demand, while products and services for which consumers have few alternatives are most often inelastic.
Economists use price elasticity of demand to measure demand sensitivity as a result of price changes for a given product. This measurement can be useful in forecasting consumer behavior and economic events, such as a recession.