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Elasticity in Economics

Elasticity in Economics

Elasticity in Economics is an essential concept that economists should master. Elasticity in Economics is the concept of sensitivity analysis of economic parameters such as demand, supply, production, employment, interest rates, prices, to name but a few. This article will expound on several types of elasticities that you might come across in your studies.

Definition of Elasticity

What does elasticity in economics mean? Elasticity describes the percentage change of a factor of interest if another impacting factor changes by one percent. For example, in their research, economists must discuss the price elasticity of demand in household theory. This kind of elasticity, therefore, describes the price sensitivity of demand. And also answers the question; how demand for goods changes in percent if the price increases by one percent. Three outcomes are consequently possible; the demand is inelastic (0 to 0,9 %), proportionally elastic (1 %), or elastic (above 1%). If the elasticity is negative, we describe it as a decrease, while positive elasticity means an increase.

\frac{(\frac{\Delta X}{X})}{(\frac{\Delta Y}{Y})}=\frac{\Delta X}{\Delta Y} \cdot \frac{Y}{X}= X'(Y) \cdot \frac{Y}{X}

Elasticity in Household Theory

In household theory, the lecturer will first confront you with the previous example of price elasticity of demand after deriving the optimal decision-making of households. The lecturer might also consider discussing the Engel-Curve using the income elasticity of demand and derive different categories of goods (normal and inferior goods). Furthermore, the lecturer will also use the cross-price elasticity to categorize goods complements and substitutes groups.

Elasticity in Theory of the Firm

 In the theory of the firm, an economist is interested in explaining the price sensitivity of input demand, input sensitivity of production levels, and the price elasticity of the firm’s supply. Each of the elasticities delivers essential information for business management. The price elasticity of input demand helps the economist analyze the flexibility of the production technology and cost structure (complement inputs and substitutional inputs). Such information allows businesses to efficiently coordinate their resource acquisition, storage, maintenance, and production plans. The second one, input elasticity of production levels, reflects the firm’s capabilities to efficiently utilize the inputs it holds and turn them to output. The third one, price elasticity of supply, reveals the firm’s competitiveness in the markets for the firm’s outcomes.

Elasticity in Market Theory

In the theory of markets, economists explain how the price elasticities of demand and supply shape market competition. When describing how taxation affects the consumer and producer surpluses, economists quantify the share of the burden between buyers and sellers by relating the outcomes with the price elasticity of demand and supply. If the market demand is more sensitive than the supply, the suppliers will carry more tax burden than demand. Such a statement will force the student to figure out how to compare the elasticities.

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