Elasticity In Economics

In Economics, Price Elasticity of Demand which is PED or Ed for short measures the responsiveness or elasticity of the quantity demanded of a good or service to the change in its price, ceteris paribus. Elasticity helps a firm to know the net effect of price and quantity effect. It gives the sellers the precise percentage change in quantity demanded in response to a one percent change in price with all other determinants of demand such as income (Y) held constant. Elasticity is useful because it measures relative magnitudes and not absolutes and helps firms to compare the responsiveness of demand across products, individuals and countries.

This paper analyzes the concept of elasticities, its uses and application to our economy.

The price elasticity of demand for a good or service is referred to by different descriptive terms depending on whether the elasticity coefficient is >, = or < than - 1. This means that the demand for a good is called relatively inelastic when Ed > -1. The only case when the demand curve is constant is in cases when it is perfectly inelastic that is the demand curve is vertical and perfectly elastic when the demand curve is vertical.

Ed = 0 -------perfectly inelastic demand

-1 < Ed < 0 ----inelastic demand Ed - 1 -------unit elasticity Ed = - ∞ -------perfectly elastic demand - ∞ < Ed < -1 –elastic

Generally, the demand of a good is said to be inelastic when the percentage change in its price causes a smaller percentage change on quantity demanded of the good or service. Price inelastic goods or services that have close substitutes like petrol, peak rail ticket, necessities such as salt and tap water and luxury goods such as diamonds with few exact alternatives. Another example of inelastic products is the health care service in America which has been found to be empirically price inelastic. The value is around –0.17. This means that a 1 percent increase in the price of health care can lead to a 0.17 percent decrease in health care expenditures. The percentage change in price and demand changes for health care is attributed to changes in accessing any care rather than to changes in the number of visits. Elasticity of demand for certain specific classes of health services is considered to be price sensitive than the demand for other types of care. Preventive care for example has several substitutes. As a result, when the price of preventive care increases, people will switch to close substitutes such as nutritional treatment and health foods. Also, preventive medical services that tend to be more of a luxury than necessity can be put off by consumers of health when such prices increases.

Demand for a good is said to be elastic when its price elasticity demanded is > 1.