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In economic, elasticity is one of the most important concepts theories. Basically, elasticity is
the ratio of the percent relative change in one variable rather than another variable.

   
×
  (X and Y are variables)

   

This measure reveals the responsiveness of a function to changes in parameters. It is useful in

understanding the incidence of indirect taxation, marginal concepts related to the theory of
the company, and distribution of wealth and different types of products related to the theory
of consumer choice. Elasticity is also strongly important in any discussion of welfare
distribution, in particular consumer surplus, producer surplus, or government surplus.

In experimental work an elasticity is the estimated coefficient in a linear regression equation

where both the dependent and the independent variable. Elasticity is a popular tool among
empiricists in terms of its independent of units and thus simplifies data analysis. [1]

Moreover, demand elasticity is important because it helps firms model the potential change in
demand due to changes in price of the good, the effect of changes in prices of other goods
and many other important market factors. A firm grasp of demand elasticity helps to guide
firms toward more optimal competitive performance. [2]
Normally, sales increase with drop in prices and decrease with rise in prices. As a
general rule, appliances, cars, confectionary and other non-essentials show elasticity of
demand whereas most necessities (food, medicine, basic clothing) show inelasticity of
demand (do not sell significantly more or less with changes in price). See also cross price
elasticity of demand. [3] When you raise the price of most items, people will buy less of
them. For example, when one airline raises its price, air passengers may switch to a rival
airline. Otherwise when you reduce the price of most items, people will buy more of them.
For example, when supermarkets make special offers with reduced prices, they expect a sharp
increase in corresponding sales. [4]
`emand elasticity is a measure of how much the quantity demanded will change if another
factor changes. For example price elasticity of demand (PE`) measures the quantity
demanded changes with price. This is important for setting prices so as to maximize profit.
[5]

Major determinant factors of the demand elasticity of are listed below:

  

 
    This is the first and foremost important factor influencing
the elasticity of a product or service. For example, if the price of a cup of coffee increased by
$0.25, consumers could replace their morning caffeine with a cup of tea. This means that
coffee is an elastic good because a raise in price will cause a large decrease in demand as
consumers start buying more tea instead of coffee. However, if the price of caffeine were to
go up as a whole, we would probably see little change in the consumption of coffee or tea
because there are few substitutes for caffeine. Most people are not willing to give up their
morning cup of caffeine no matter what the price. We would say, therefore, that caffeine is an
inelastic product because of its lack of substitutes. Thus, while a product within an industry is
elastic due to the availability of substitutes, the industry itself tends to be inelastic. Usually,
unique goods such as diamonds are inelastic because they have few if any substitutes.

  

 






  This factor affecting demand elasticity
refers to the total a person can spend on a particular good or service. Thus, if the price of a
can of Coke goes up from $0.50 to $1 and income stays the same, the income that is available
to spend on coke, which is $2, is now enough for only two rather than four cans of Coke. In
other words, the consumer is forced to reduce his or her demand of Coke. Thus if there is an
increase in price and no change in the amount of income available to spend on the good, there
will be an elastic reaction in demand; demand will be sensitive to a change in price if there is
no change in income.

: The third influential factor is time. If the price of cigarettes goes up $2 per pack, a
smoker with very few available substitutes will most likely continue buying his or her daily
cigarettes. This means that tobacco is inelastic because the change in price will not have a
significant influence on the quantity demanded. However, if that smoker finds that he or she
cannot afford to spend the extra $2 per day and begins to kick the habit over a period of time,
the price elasticity of cigarettes for that consumer becomes elastic in the long run.
· 



    The price elasticity of demand for necessary goods is very low
as they are purchased even at a higher price. However there is more elasticity of demand in
the case of luxury goods as they need not be purchased for satisfying a basic essential need
and their purchase can be postponed to a future day.



 The very highly priced items like diamonds and low priced items like pencils
have low price elasticity of demand as change in their prices has very little effect on their
consumers. [6] [7]

Elasticity of demand include price elasticity of demand, price elasticity of supply, income
elasticity of demand, elasticity of substitution between factors of production and elasticity of
intertemporal substitution.


  

Price elasticity of demand (PE` or Ed) is a measure used in economics to show the
responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its
price. More precisely, it gives the percentage change in quantity demanded in response to a
one percent change in price (holding constant all the other determinants of demand, such as
income). It was devised by Alfred Marshall.

Price elasticities are almost always negative, although analysts tend to ignore the sign even
though this can lead to ambiguity. Only goods which do not conform to thelaw of demand,
such as Veblen and Giffen goods, have a positive PE`. In general, the demand for a good is
said to be inelastic (or relatively inelastic) when the PE` is less than one (in absolute value):
that is, changes in price have a relatively small effect on the quantity of the good demanded.
The demand for a good is said to beelastic (or relatively elastic) when its PE` is greater than
one (in absolute value): that is, changes in price have a relatively large effect on the quantity
of a good demanded.

Revenue is maximised when price is set so that the PE` is exactly one. The PE` of a good
can also be used to predict the incidence (or "burden") of a tax on that good. Various research
methods are used to determine price elasticity, including test markets, analysis of historical
sales data and conjoint analysis.
PE` is a measure of the sensitivity (or responsiveness) of the quantity of a good or service
demanded to changes in its price. The formula for the coefficient of price elasticity of
demand for a good is: [8]

(  ! * + ,
    ! "#$$ )&  ! -* . , /01
×   
   %&' ( %&' %* + %,
)& %&' -%* . %, /01

   2 ! $#$$

× 
   3&'

The price elasticity of demand is commonly divided into one of five elasticity alternatives;
perfectly elastic, relatively elastic, unit elastic, relatively inelastic, and perfectly inelastic,
depending on the relative response of quantity to price. These five alternatives form a
continuum of possibilities.

The below chart displays five alternatives based on the coefficient of elasticity (E). [10] The
negative value obtained when calculating the price elasticity of demand is ignored. This
formula usually yields a negative value, due to the inverse nature of the relationship between
price and quantity demanded, as described by the "law of demand". For example, if the price
increases by 5% and quantity demanded decreases by 5%, then the elasticity at the initial
price and quantity = í5%/5% = í1. The only classes of goods which have a PE` of greater
than 0 are Veblen and Giffen goods. Because the PE` is negative for the vast majority of
goods and services, however, economists often refer to price elasticity of demand as a
positive value (i.e., in absolute value terms). [9]


 

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The price elasticity of demand for a particular demand curve is influenced by the following
factors:
Ô   

    the greater the number of substitute products, the greater the
elasticity.
Ô 

 

 luxury products tend to have greater elasticity than
necessities. Some products that initially have a low degree of necessity are habit forming
and can become "necessities" to some consumers.
Ô     

 




  products requiring a larger portion of the
consumer's income tend to have greater elasticity.
Ô 
 
  elasticity tends to be greater over the long run because
consumers have more time to adjust their behavoir to price changes.
Ô 

 


 a one-day sale will result in a different response
than a permanent price decrease of the same magnitude.
Ô 
   decreasing the price from $2.00 to $1.99 may result in greater increase in
quantity demanded than decreasing it from $1.99 to $1.98. [11]

! 
  

In economics, income elasticity of demand measures the responsiveness of the demand for a
good to a change in the income of the people demanding the good, holding all prices
constant. It is calculated as the ratio of the percentage change in demand to the percentage
change in income. [12] Income elasticity of demand measures the relationship between a
change in quantity demanded and a change in income. The basic formula for calculating the
coefficient of income elasticity is:

   2 ! $#$$

× 
   & '4#

Normal goods have a positive income elasticity of demand so as income rise more is demand
at each price level. We make a distinction between normal necessities and normal luxuries
(both have a positive coefficient of income elasticity).

Necessities have an income elasticity of demand of between 0 and +1. `emand rises with
income, but less than proportionately. Often this is because we have a limited need to
consume additional quantities of necessary goods as our real living standards rise. The class
examples of this would be the demand for fresh vegetables, toothpaste and newspapers.
`emand is not very sensitive at all to fluctuations in income in this sense total market
demand is relatively stable following changes in the wider economic (business) cycle.

Luxuries on the other hand are said to have an income elasticity of demand > +1. (`emand
rises more than proportionate to a change in income). Luxuries are items we can (and often
do) manage to do without during periods of below average income and falling consumer
confidence. When incomes are rising strongly and consumers have the confidence to go
ahead with ³big-ticket´ items of spending, so the demand for luxury goods will grow.
Conversely in a recession or economic slowdown, these items of discretionary spending
might be the first victims of decisions by consumers to rein in their spending and rebuild
savings and household financial balance sheets.

In other word:

‡ A positive sign denotes a normal good

‡ A negative sign denotes an inferior good

For example:

‡ Yed = - 0.6: Good is an  
  but   ± a rise in income of 3% would
lead to demand falling by 1.8%.
‡ Yed = + 0.4: Good is a  
  but   ±
a rise in incomes of 3% would lead to demand rising by 1.2%.
‡ Yed = + 1.6: Good is a  
  and   ±
a rise in incomes of 3% would lead to demand rising by 4.8%.
‡ Yed = - 2.1: Good is an  
  and   ±
a rise in incomes of 3% would lead to a fall in demand of 6.3%.
 

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Cross price elasticity of demand measures how much demand of one good, say x changes
when the price of another good, say y changes, holding everything else constant. For
example, you can measure what happens to the demand of bread when the price of milk
changes. The cross price elasticity is calculated as the percentage change in the quantity
demanded of good x divided by the percentage change in the price of good. If the cross price
elasticity is negative, then we call such goods Complements (example: pizza and soft drinks -
- they are consumed together). If the cross price elasticity is positive, then we call such goods
Substitutes (example: pizza and burgers -- you usually consume either or). The income
elasticity of demand measures the change in the quantity demanded of some good, when the
income changes, holding everything else constant. For example you can measure what
happens to the demand for expensive red wine when income increases. The income elasticity
is calculated as the percentage change in the quantity demanded of the good divided by the
percentage change in income. If the income elasticity for a good is positive we call them
normal goods. It can be between 0 and 1, and we call it income inelastic demand for goods
such as food, clothing, newspaper. If it is above 1, we call it income elastic demand.
Examples are the red wine, cruises, jewelry, art, etc. If the income elasticity is negative, this
means that as income increases, the quantity demanded for those goods actually decreases,
we call those goods inferior goods. Examples are "Ramen noodles", cheap red wine, potatoes,
rice. etc. [15]

Price elasticity of demand (PE`) measures the responsiveness of quantity demanded when
there is a change in price of the particular good you are examining. Cross elasticity of
demand measures the responsiveness of quantity demanded when there is a change in price of
other goods. PE` is always a negative value because the quantity demanded and price have
an inverse relationship, i.e when price increases, quantity demanded will decrease and vice
versa, whereas CE` can be either positive or negative. It all depends on the nature of the
goods you're examining. Two types of goods that play an influential role in determining CE`
of a good is Complementary goods and Substitute goods. Take for example, CE` of
substitute goods are always positive. This is because the quantity demanded for the substitute
goods has a positive relationship with the price of the initial good, i.e when price of initial
good drops, the quantity demanded for substitute goods will drop as well. This is because
consumers will always opt for the cheaper alternative, which in this case is the initial good,
thus quantity demanded for its substitutes will decrease.

On the other hand income elasticity is the degree to which demand for a good will change
relative to a change in the spending power of the consumer. [16]