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COEFFICIENT OF ELASTICITY:
A numerical measure of the relative response of one variable to changes in another variable. The coefficient of elasticity is used to quantify the concept of elasticity, including price elasticity of demand, price elasticity of supply, income elasticity of demand, and cross elasticity of demand. The coefficient can be calculated using the simple endpoint or midpoint formulas or with more sophisticated calculus and logarithmic techniques. The coefficient of elasticity captures the elasticity response between two variables, often with a single value. For example, in the analysis of the market, the law of demand relation between price and quantity is commonly indicated with a coefficient for the price elasticity of demand. A comparable coefficient for the price elasticity of supply is used to indicate the law of supply relation between price and quantity.
A General FormulaThe general formula for the coefficient of elasticity between variables A and B is given as:
This general formula takes a more specific form for actual calculations. One of the more common specific forms used is the midpoint elasticity formula:
in variable B
in variable A
The first term on the right-hand side of the equation is the percentage change in variable B. The second term is the percentage change in variable A. The individual items are interpreted as this: A1 is the initial value of A before any changes, A2 is the ending value after A changes, B1 is the initial value of B before any changes, and B2 is the ending value after B changes.
|(B2 - B1)
(B2 + B1)/2
|(A2 - A1)
(A2 + A1)/2
Four Common ElasticitiesThe most common applications for the coefficient of elasticity are price elasticity of demand and price elasticity of supply. Two other notable applications are income elasticity of demand and cross elasticity of demand.
While these four elasticities tend to make the greatest use of the coefficient of elasticity, whenever an elasticity relationship between two variables needs to be quantified, the coefficient of elasticity is bound to come into play.
- Price Elasticity of Demand: On one side of the market is the price elasticity of demand. This is the relative response of quantity demanded to changes in the price. It is specified as 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 also 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 due 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.
Follow the SignsThe positive and negative values resulting from calculating the coefficient of elasticity is generally important. The negative value for the price elasticity of demand indicates the law of demand and the positive value for the price elasticity of supply indicates the law of supply. However, the negative value of the demand elasticity is often ignored for comparison with supply elasticity and easy classification as perfectly elastic, relatively elastic, unit elastic, relatively inelastic, and perfectly inelastic.
In contrast, the positive and negative values for income elasticity of demand and cross elasticity of demand are important. A positive income elasticity indicates a normal good, and a negative value indicates an inferior good. A positive cross elasticity indicates a substitute good, and a negative value indicates a complement good.
Calculation AlternativesThe coefficient of elasticity can be calculated using several different techniques. In most introductory (classroom-type and textbook-type presentations), the coefficient of elasticity is calculated using the midpoint elasticity formula. While the midpoint formula is a relatively simple calculation, requiring only simply arithmetic, it often provides only an approximation of the actual elasticity of a relation, especially for a demand curve with a constant slope.
More sophisticated coefficient of elasticity calculations can be had using more sophisticated mathematical techniques, including calculus and logarithmic equations. Whereas the midpoint elasticity formula indicates an average elasticity over a segment of a curve, point elasticity is the elasticity at a given point on a curve.
COEFFICIENT OF ELASTICITY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 2, 2024].
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