Elasticity, in general, is the responsiveness of one variable due to a change in a different variable. In economics, the concept of elasticity helps us understand how demand and supply change due to changes in related variables, such as income, price, and more. Generally, when we talk about elasticity in economics, we usually talk about it in relation to demand and supply. For instance, how variables such as price, income, and more affect the demand and supply in the market. There are different types of elasticity that help in explaining the impact of changes in different variables. In this article, we will be discussing what are the types of elasticity.
What are the Types of Elasticity?
There are mainly four types of elasticity that tells about the sensitivity of demand and supply with regard to the changes in different variables. Following are the four types of elasticity:
Price Elasticity of Demand
We usually call this PED (Price Elasticity of Demand). As the word suggests, it tells how a change in price impacts demand. We can measure the PED in two ways. First is arc elasticity, which measures elasticity over a price range. And second is point elasticity, which calculates the elasticity at a point.
The bigger the PED, the more responsive the demand is to the price. Some products that are known to be price inelastic are salt, gasoline, medicines, and more.
There are many factors that affect the price elasticity of demand, including the availability of substitutes, if the product is a necessity or a luxury, and the percentage of income a consumer spends on a product.
If a product has close substitutes available, then that product will have a price elastic demand. It means that consumers will switch to substitutes if the price of the product rises. Similarly, price elasticity is more for a luxury product but less for products that are a necessity, such as insulin.
If a user spends a small part of their income on buying the product, then that product has a low price elasticity of demand. And, if the percentage spent is big, then the price elasticity will be high. This is because an increase in the price of the product would have a significant impact on a budget of the consumer.
Cross Elasticity, as the word suggests, tells about the change in demand for one product due to a change in the price of another product. We can work it out by dividing the % change in the demand for a product by the % change in the price of another product. Another name for this elasticity is the cross-price elasticity of demand. When this type of elasticity between the products is positive, it means that the products are substitutes.
It means the change in the demand for a product or service due to a change in the real income of a user. We can measure the income elasticity of demand by dividing the % change in the demand for a product or service by the % change in the income. Calculating such elasticity also tells if the product is a necessity or inferior.
If this elasticity is positive, it implies that the product is a normal product. This means a rise in income would lead to a jump in demand. And, if the income elasticity is negative, the product is usually an inferior product. It would mean the demand drops when the income goes up because consumer switches to better products.
Price Elasticity of Supply
All three types of elasticity above were for the demand, but this fourth one is for the supply. We also call this elasticity PES or Price Elasticity of Supply. This elasticity tells about the sensitivity of the supply of a product or service because of a change in its market price. The law of supply says that the supply increases when the prices go up and drop when prices go down. But how much the supply changes due to the price? This is what PES tells.
The concept of elasticity is very important in explaining consumer behavior. And the concept is extremely important for businesses as well. It is vital for businesses to know if the demand for their product or service is elastic or inelastic. Such information will help them to come up with strategies, especially the strategies to correctly market their product or service.
To learn more about elasticity, refer to our article How Does Elasticity Work?