Economics Online Tutor
Elasticity is a term used in economics to denote responsiveness.  It is a
measurement of the responsiveness, or sensitivity, of one variable to a
change in another variable.

Elasticity has a variety of uses in economics.  For example, when a company
is deciding on a pricing strategy, it needs to know which proposed price will
generate the most total revenue.  The elasticity measurement will answer
that question.  Another example would be a producers' tax proposed on the
sale of a particular product.  How much of the tax will the producers pay, and
how much of it will the consumers end up paying through higher prices?  
How much tax will be collected? How much will this change the quantity of
the product that consumers purchase?  The answers depend on the
elasticity measurement.  In the extreme case of price controls imposed by
the government: price controls distort market equilibrium, but how much
will output fall with price controls? Elasticity again determines the answer.

Many students have trouble understanding elasticity because the concept
is often taught with the use of formulas that look cumbersome, and are
difficult to memorize.  The way I explain it here is different.  I teach the
concepts behind the formulas.  All it takes is an understanding of the
concepts, and the formulas just fall into place.  The is no need for
memorization.  Students who understand the concepts, beginning with the
explanation in the following paragraphs, should have no difficulty with the
numbers or formulas involved.

So here is the first, and most important concept: the discussions relating to
specific types of elasticities, with links in the list to the left, follow from an
understanding of this:

All types of elasticities are numbers, which represent measurements based
on two variables.  These measurements are formed using division, and are
based on percentage changes in each variable used.

These measurements are formed by dividing the percentage change in one
(dependent) variable by the percentage change in another (independent)
variable.  This should be easier to understand by realizing that it is a formula
that will yield a number; by putting the dependent variable on top the result
will be a measure of its responsiveness to changes in the independent

The results of such a formula will center around the number 1 (that is the
case, mathematically, when division is used to compare 2 numbers).  Higher
than 1 means, mathematically, that the top number is larger than the bottom
number; lower than 1, the bottom number is larger than the top number; and
equal to 1, the two numbers are identical.

Higher than 1 (representing a change in the top number that is greater than
the change in the bottom number) is relatively responsive, and is called
elastic; lower than 1 (representing a change in the bottom number that is
greater than the change in the top number) is relatively unresponsive and
is called inelastic; equal to 1 means that the changes are neutral, and is
called unit elastic.

This covers all situations, but the extreme cases where one variable does
not change at all with any change in the other variable (either the top or the
bottom of the formula equals zero) have special names: Perfectly elastic
(zero for the bottom number, or infinite elasticity) and perfectly inelastic
(zero for the top number, or zero elasticity).

For an explanation of specific topics relating to elasticity in economics, click
on the links on the left side of this page.  Most students start with the
elasticity of demand.

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