Elasticity in Economics

Readers Question: I have to write a paper on when it would be a good time to own a business that sells price elastic products, I have read the text and looked on this web site and am still confused as to what price elasticity really is. Should i get the Economics for Dummies book???

• If the price of salt increases, will you reduce demand for salt?
• If the price of volvic mineral water increases, would you reduce demand for volvic?
• If the price of electricity increases, would you reduce demand?
• If the price of a Vodaphone mobile phone increased, would you still buy it?

All these questions relate to the issue of elasticity. Price elasticity of demand measures how responsive demand is to a change in price. Some goods like salt are price inelastic because if the price of salt increases, people will generally keep buying it. e.g. a 10% increase in price, may reduced demand for salt by only 1%. We say the PED of salt is -1/10 = -0.1

However, if the price of volvic mineral water increased by 10% many consumers would buy other types of mineral water. This is because volvic mineral water has many close substitutes – Evian, Vittel, Gerolsteiner e.t.c.

Therefore, a 10% increase in the price of volvic water may reduce demand by 18%. Therefore, the PED of volvic is -18/10 = -1.8. We say that Volvic has an elastic demand – it is sensitive to changes in price.

Price Inelastic demand.

We say demand is inelastic if a change in prices causes a smaller % fall in demand. Examples, include

• petrol
• salt
• Tobacco
• Electricity
• Gas

All these goods are seen as necessary by consumers. If the price of electricity goes up, you will still use it to turn on lights and your TV. You can’t plug  your TV into the gas socket. Electricity is inelastic because it doesn’t have any close substitutes. It is the same for petrol and salt.

Elastic Goods

This means a change in price leads to a bigger % change in demand. Elastic goods will be anything with many substitutes or luxury items that are expensive to buy e.g.

• Tesco Bread
• Tesco Value Baked Beans
• Sports car outside
• Designer label Clothes

Therefore, a firm could cut price and gain a bigger % increase in demand. These are goods with many substitutes. E.g. if Volvic cut its price by 10%, it may gain an 18% increase in market share (unless other firms also cut prices)

It is good to have elastic goods, if you can cut prices, without your competitors following suit.

• Understanding Elasticity