Lesson Overview
Supply and demand explain direction — but elasticity explains magnitude.
Elasticity measures how responsive quantity demanded or supplied is to a change in price. Some markets react dramatically to price changes, while others barely respond at all.
Learning Objectives
- Define price elasticity of demand.
- Define price elasticity of supply.
- Distinguish between elastic, inelastic, and unit elastic.
- Explain how elasticity affects total revenue.
Price Elasticity of Demand (PED)
Price elasticity of demand measures how much quantity demanded changes when price changes.
Formula:
Elasticity = (% Change in Quantity Demanded) ÷ (% Change in Price)
Elastic vs. Inelastic
- Elastic (>1) — Quantity changes more than price.
- Inelastic (<1) — Quantity changes less than price.
- Unit Elastic (=1) — Quantity changes proportionally with price.
What Makes Demand Elastic?
- Availability of substitutes
- Luxury vs. necessity
- Time to adjust
- Share of income spent on the good
Gasoline is relatively inelastic in the short run. Luxury vacations are typically elastic.
Total Revenue Test
Total Revenue = Price × Quantity
- If demand is elastic, price increases reduce total revenue.
- If demand is inelastic, price increases raise total revenue.
Businesses rely heavily on elasticity when setting prices.
Price Elasticity of Supply (PES)
Price elasticity of supply measures how responsive producers are to price changes.
What Makes Supply Elastic?
- Time to adjust production
- Availability of inputs
- Flexibility of production processes
Agricultural goods tend to have inelastic supply in the short run but more elastic supply over time.
Practice Questions
- If price rises 10% and quantity demanded falls 20%, is demand elastic or inelastic?
- Why might life-saving medicine be inelastic?
- Why does supply become more elastic over longer time horizons?
Reflection
Think about a product you buy regularly.
- Would you continue buying it if the price doubled?
- What alternatives exist?
- Is your demand elastic or inelastic?
What’s Next?
In Lesson 2.5: Market Efficiency, we examine how elasticity interacts with surplus and deadweight loss.