Elasticity Is a Concept in Microeconomics That

Elasticity is a concept in microeconomics that reflects "the degree to which a demand or supply curve varies among products" (Investopedia, 2013). Thus, the degree to which demand or supply of a good changes with a change in the price. This dynamic can be calculated using the following formula: Elasticity = (% change in quantity / % change in price) In general, a good is characterized as elastic if the change in quantity is greater than the change in price, in other words if E > 1.

If the change in quantity is lesser than the change in price, demand for the good is considered to be inelastic. If the demand changes exactly as the price changes, in order words if E = 1, then the good is said to be perfectly elastic. Perfect elasticity is uncommon, and is observed mostly in theoretical examples (Moffatt, 2013). There is also reverse elasticity. This situation arises when elasticity is inverse, in order words if E < 0. This situation can occur with luxury goods.

The reason for this is that the utility in buying a luxury good is not just based on the intrinsic value of the good, but on the prestige associated with the good. If the good is too affordable, the prestige value is minimal. If the price of the good increases, then the prestige increases.

Since much of the utility of the good derives from the prestige, the demand for the good is likely to be reverse elastic to some degree, where an increase in the price actually results in an increase in sales. There are several other factors that need to be considered with respect to the issue of elasticity. The first is that there are several factors that affect elasticity. The most basic factor is the importance of the good. Some goods are inelastic because they are considered to be necessities.

This is the case for something like gasoline, which has very low elasticity of demand in the short run, and only slightly higher elasticity in the long run. People who live in places where driving is the only way to get around need gasoline, and there are constraints on how much their consumption can change with the price at the pump. However, for something like cola that is not a necessity, price elasticity of demand will be higher.

If the price of gas increases $2/gallon, consumption will only decline slightly; if cola increases $2/gallon, consumption will decrease much more. One of the other key factors affecting elasticity is the availability of substitutes. Gas and cola provide a good illustration of how this works. Where substitutes are readily available, consumers are apt to substitute when the price of a good increases. For cola, people will simply find other beverages to consume if the price of cola increases dramatically. There are many good options, most of which are widely available.

This is not the case with gasoline. There are substitutes -- riding a bicycle, taking the train -- but these are often poor substitutes and for many consumers are a non-starter. The lack of substitutes contributes significantly to the inelasticity for gasoline. The first example of the luxury good highlights another key concept when considering elasticity in microeconomics. While price is the form of elasticity talked about most, elasticity of demand can be based on any attribute. The key is that consumers buy things for the utility they receive.

Price is one characteristic of a good, but consumers derive utility from a wide range of product attributes. Any product attribute that contributes to the utility of a good will have some form of elasticity attached to it. Certainly, it might be more difficult to measure elasticity of non-numeric attributes (for example, customer service) but there is an observable correlation between the quality of customer service at a company and the demand for that company's business. This is also elasticity.

A final issue with respect to elasticity relates to cross-price elasticity of demand. This refers to the change in demand for one good based on the change in price of another. Usually where cross-price elasticity exists, the set of goods in question are either substitutes or complements. There can be cross elasticities without price as well. For example, the demand for gasoline might have a cross-price elasticity with the price of subway tickets.

Or, the demand for gasoline might have cross elasticity with the availability of a public transportation network -- demand for gasoline might fall when a new subway line is opened. Elasticity can also be observed.