Elasticity (economics)

Elasticity (economics)

In economics, elasticity is the measurement of how changing one economic variable affects others. For example:

• "If I lower the price of my product, how much more will I sell?"
• "If I raise the price, how much less will I sell?"
• "If we learn that a resource is becoming scarce, will people scramble to acquire it?"

In more technical terms, it is the ratio of the percentage change in one variable to the percentage change in another variable. It is a tool for measuring the responsiveness of a function to changes in parameters in a unitless way. Frequently used elasticities include price elasticity of demand, price elasticity of supply, income elasticity of demand, elasticity of substitution between factors of production and elasticity of intertemporal substitution.

Elasticity is one of the most important concepts in neoclassical economic theory. It is useful in understanding the incidence of indirect taxation, marginal concepts as they relate to the theory of the firm, and distribution of wealth and different types of goods as they relate to the theory of consumer choice. Elasticity is also crucially important in any discussion of welfare distribution, in particular consumer surplus, producer surplus, or government surplus.

In empirical work an elasticity is the estimated coefficient in a linear regression equation where both the dependent variable and the independent variable are in natural logs. Elasticity is a popular tool among empiricists because it is independent of units and thus simplifies data analysis.

Generally, an elastic variable is one which responds a lot to small changes in other parameters. Similarly, an inelastic variable describes one which does not change much in response to changes in other parameters. A major study of the price elasticity of supply and the price elasticity of demand for US products was undertaken by Hendrik S. Houthakker and Lester D. Taylor.