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Elasticity
Elasticity measures responsiveness, and is very useful when studying the impact of pricing on supply and
demand.
What It Measures
The percentage change of one variable caused by apercentage change in another variable.
Why It Is Important
Elasticity is defined as “the measure of the sensitivity of one variable to another.” In practical terms,
elasticity indicates the degree towhich consumers respond to changes in price. It is obviously important for
companies to consider such relationships when contemplating changes in price, demand, and supply.
Demand elasticity measureshow much the quantity demanded changes when the price of a product or
service is increased or lowered. Will demand remain constant? If not, how much will demand change?
Supply elasticity measuresthe impact on supply when a price is changed. It is assumed that lowering prices
will reduce supply, because demand will increase—but by how much?
How It Works in Practice
The general formula forelasticity is:
Elasticity = Change in x (%) ÷ Change in y (%)
In theory, x and y can be any variables. However, the most common application measures price and
demand. If the price of a product isincreased from \$20 to \$25, or 25%, and demand in turn falls from 6,000
to 3,000 (–50%), elasticity would be calculated as:
–50 ÷ 25 = –2
A value greater in magnitude than ±1 means that demand isstrongly sensitive to price, while a lesser value
means that demand is not price-sensitive.
Tricks of the Trade
• There are five cases of elasticity:
– E = 1, or unit elasticity. The proportionalchange in one variable is equal to the proportional
change in another variable: if price rises by 5%, demand falls by 5%.
– E is greater than 1, or just elastic. The proportional change in x is greaterthan the proportional
change in y: if price rises by 5%, demand falls by 3%.
– E = infinity, or perfectly elastic. This is a special case of elasticity: any change in y will effect
no change in x....