Explaining Elasticity

Open any micro textbook, and this is the definition of elasticity of demand that you will find (more or less):

“The percentage change in quantity demanded, given a percentage change in price”

Here is what it means, in practice. Say you’re a shopkeeper selling plain black umbrellas. Let’s say you sell them for a hundred rupees each. At this price, every month, you are able to sell 100 of them.

One especially sleepy Tuesday afternoon, you think to yourself that it’s been a while since I hiked the price at which I sell these umbrellas, so let’s start selling ’em at 110 rupees tomorrow.

All right, so do you still expect to sell 100 umbrellas this month, now that the price is 110 instead of 100? Do you expect to sell more than 100, less than 100? The answer to this question is the elasticity of demand for plain black umbrellas in your shop. One would think it’s fair to assume that the demand will go down with an increase in price. By how much, though?

There’s been a 10 percent increase in price. Will there be a 10 percent decrease in demand? If so, then the elasticity of demand for black umbrellas is -1. Economists usually leave out the “minus” since that’s more or less a given. If the percentage change in quantity demanded is the same as the percentage change in price, we say that the good in question has unitary elasticity.

What if there is a higher than 10 percent change in quantity demanded given a percentage change in price? What if, say, the percentage change in quantity demanded is 20 percent – what if you now sell only 80 umbrellas? In that case 20/10=2 – the elasticity will be 2.

Here’s the math: 20 percent because (80-100)/100=-20 percent, and 10 percent because (110-100)/100=10 percent.

We call the demand for such goods elastic. That is, a slight change in price leads to large changes in demand.

Similarly, if there is a small fall in demand – say, you sell 99 umbrellas instead of 100, elasticity in that case would be 0.1 (try and work out the math yourself). And we would then call the demand for this good inelastic. That is, changes in price have little to no impact upon quantity demanded.

If you’re learning about elasticity for the first time, though, it might be best to not get caught up in the math right away, and think through the intuition:

If I increase the price of a good a little bit, will the change in quantity demanded be as much as the change in price, or less, or more?

The quantifiable response to that question is the measurement of elasticity. It’s what allows Apple to never give a discount on their latest iPhones, and it’s what keeps goods on Myntra on near permanent sales.

And we’ll be taking a look at some real life examples in the next blog post!

Author: Ashish

Blogger. Occasional teacher. Aspiring writer. Legendary procrastinator. View all posts by Ashish