Since the laws of supply and demand set price, prices are always subject to change based upon market forces and the interaction between the consumer and business. This change in prices and the degree of said change is known as elasticity.
There are two types of elasticity that we need to be concerned with. They are demand elasticity and supply elasticity.
Demand Elasticity – the degree to which changes in price effect changes in demand. Demand is elastic when a small change in price effects a large change in demand. Such products, that show great variability in demand are known to have elastic demand.
Demand is inelastic when a change in price does not bring about a correspondingly large change in demand, or any change at all. Said products are known to show inelastic demand.
How can we tell if an item is will be elastic or inelastic? The elasticity of demand can usually be estimated by examining the answers to three key questions. All three answers do not have to be the same in order to determine elasticity, and in some cases the answer to a single question is so important that it alone might dominate the answers of the other two. Let’s examine the three questions.
- Can the purchase be delayed?
The ability to delay or postpone the purchase of a product is one of the determinants of elasticity. If the purchase can be delayed, the demand for the product tends to be elastic. If it cannot be delayed it tends to be inelastic.
For example, since I can wait to buy a new stereo until the price drops demand will vary greatly in accordance with price. This product thus would tend to be elastic. Gasoline, on the other hand, I cannot wait for. Thus demand does not vary greatly with price and the product tends to be inelastic.
- Are adequate substitutes available?
If a product has many substitutes, the demand for it tends to be elastic. The fewer substitutes available for a product, the more inelastic the demand. Note we are talking about product not brand!
For example, if the price of coffee were to go up dramatically then many people would switch to tea, thus a substitute is available. Since this is the case the price is causing demand to drop. This product would then be considered elastic. Since there is no real substitute for gasoline of heating oil, demand remains the same regardless of price. These products are inelastic.
- Does the purchase use a large portion of income?
If a product is expensive, and is a large percentage of one’s income, then the product tends to be more elastic. If a product is not a significant portion of the income the product tends to be more inelastic.
Take a house for example, if prices were to drop, demand would go up alot. The same holds true for a car. A bar of soap, steak, clothes, since even an expensive product can be readily afforded the change in price is not a tremendous factor in demand.
Elasticity of Supply – When supply goes up price goes down and when price goes up supply goes down. Products are elastic if price has a large impact on supply, they are inelastic if supply remains relatively constant due to fluctuations in price.
Factors which effect supply elasticity are: Price, resource costs, technology, competitive products, profit expectations, number of sellers, natural events, taxes, subsidies and government regulations, overproduction, flooding the market, inability to produce an item, scarcity of natural resources.
Watch the video below and learn more about elasticity