Although elasticity most often surfaces in the study of markets, it is applied to a wide range of economic topics involving a connection or cause-and-effect relation between two variables. The analysis of short-run production by a firm often finds use for elasticity of substitution between labor and capital inputs. The analysis of monetary policy employs the interest rate elasticity of investment expenditures.

Stretchability

Suppose, for example, that Duncan Thurly, as Sergent at Arms of the Shady Valley Bungee Association, has been charged with installing and testing the bungee straps for the 12th Annual Bungee Jump Off. As the first one to plunge 500 feet from a bridge, he is admittedly concerned that the appropriate bungee straps are used.

Options include:

• Steel, which has some stretchability, but not a lot. A great deal of force is needed to induce changes in the steel. The jumpers are likely to end up with a sudden, spine-snapping, joint-separating stop.


• Leather, which has more stretchability than steel, but once again, probably not enough.


• Rubber, which is relatively stretchable, would seem to be an ideal candidate. However, Duncan must make sure that the rubber is not too stretchable. If so, then the jumpers are bound to have an unscheduled meeting with a pile of jagged rocks.

Elastic and Inelastic: Dog Eats Homework

Alternatively, suppose that Maurice has eyewitness accounts from the five most reputable citizens of Shady Valley, provides an affidavit from three veterinarian's attesting to the homework contents of the dog's stomach, and replays a videotape of the actual dog-eating-homework debacle. If Professor Grumpinkston changes Maurice's grade from a D to a D+, then he is not very "elastic."

Professor Grumpinkston's response to Maurice's dog story suggests that elasticity can be generally classified as either elastic or inelastic.

• Elastic: This exists if small changes in one variable cause relatively large changes in another variable. An elastic relationship between two variables is a very responsive, or stretchable, relationship.


• Inelastic: This exists if large changes in one variable cause relatively small changes in another variable. An inelastic relationship between two variables is not a very responsive, or stretchable, relationship.

Taking Measures

coefficient of elasticity

=

percentage change in variable B percentage change in variable A

midpoint elasticity

=

(B2 - B1) (B2 + B1)/2

÷

(A2 - A1) (A2 + A1)/2

Demand and Supply

• Price Elasticity of Demand: At the top of the list is the price elasticity of demand. This is the relative response of quantity demanded to changes in the price. More specifically, it is the percentage change in quantity demanded to a percentage change in price.


• Price Elasticity of Supply: On the other side of the market is the price elasticity of supply. This is the relative response of quantity supplied to changes in the price. It is analogously specified as the percentage change in quantity supplied to a percentage change in price.

• Income Elasticity of Demand: This is the relative response of demand to changes in income, or the percentage change in demand to a percentage change in income. This elasticity quantifies the buyers' income demand determinant.


• Cross Elasticity of Demand: This is the relative response of demand to changes in the price of another good, or the percentage change in the demand for one good due to a percentage change in the price of the other good. This elasticity quantifies the other prices demand determinant.

A Range of Elasticity

Alternative	Coefficient (E)
Perfectly Elastic	E = ∞
Relatively Elastic	1 < E < ∞
Unit Elastic	E = 1
Relatively Inelastic	0 < E < 1
Perfectly Inelastic	E = 0

The chart to the right displays the five alternatives based on the coefficient of elasticity (E). The negative value obtained when calculating the price elasticity of demand is ignored to allow for comparison with the price elasticity of supply.

• Perfectly Elastic: The top of the chart begins with perfectly elastic, given by E = ∞. Perfectly elastic means an infinitesimally small change in price results in an infinitely large change in quantity demanded or supplied.


• Relatively Elastic: The second category is relatively elastic, in which the coefficient of elasticity falls in the range 1 < E < ∞, between one and infinity. With relatively elastic demand and supply, relatively small changes in price cause relatively large changes in quantity. Quantity is very responsive to price. The percentage change in quantity is greater than the percentage change in price.


• Unit Elastic: The third category is unit elastic, in which the coefficient of elasticity is E = 1. In this case, any change in price is matched by an equal relative change in quantity. The percentage change in quantity is equal to the percentage change in price. Unit elastic is essentially a dividing line or boundary between elastic and inelastic.


• Relatively Inelastic: The fourth category is relatively inelastic, in which the coefficient of elasticity falls in the range 0 < E < 1, between zero and one. With relatively inelastic demand and supply, relatively large changes in price cause relatively small changes in quantity. Quantity is not very responsive to price. The percentage change in quantity is less than the percentage change in price.


• Perfectly Inelastic: The final category presented in this chart is perfectly inelastic, given by E = 0. Perfectly inelastic means that quantity demanded or supplied are unaffected by any change in price. The quantity is essentially fixed. It matters not how much price changes, quantity does not budge.

Three Determinants

• Availability of Substitutes: The ease of substitution between goods, both in consumption and production, has a big effect on elasticity. The ease with which buyers can find substitutes-in-consumption affects the price elasticity of demand and the ease with which sellers can switch resources to substitutes-in-production affects the price elasticity of supply. The general rule is that goods with a greater availability of substitutes is more sensitive to price changes. With more substitutes available, buyers and sellers can easily respond to price changes.


• Time Period of Analysis: The longer the time period of analysis, the more responsive quantities are to price changes, for both price elasticity of demand and price elasticity of supply. Brief periods do not allow buyers and sellers the time needed to adjust consumption and production decisions to price changes. Buyers need time to find substitutes-in-consumption. Sellers need time to find resources used for substitutes-in-production. Longer time periods allow buyers and sellers the time needed to find alternatives.


• Proportion Of Budget: The price elasticity of demand depends on the proportion of the budget that buyers devote to a good. The rule is this: The larger the portion, the more responsive quantity demanded is to price changes. A house, for example, is a BIG budget item for most normal human beings. A relatively small change, say 1 percent on a $100,000 house, can make a BIG difference in the buyer's decision to buy. As such, relatively small changes in price are likely to induce relatively large changes in quantity demanded.