4.2: Elasticity

Sensitivity

If one word could describe the concept of elasticity it would be sensitivity. Elasticity is basically a sensitivity test.

Question: Whose sensitivity is being tested?

Answer: Suppliers and demanders.

Elasticity tests supplier and demander sensitivity to changes in market conditions.

Building Upon the Laws of Supply and Demand

We know the basics about how suppliers and demanders react to changes in market conditions. For example:

• When the price of goods increases, the quantity demanded decreases.
• When incomes of demanders increases, the overall quantity demanded increases (assuming it is a normal good)
• When the price of goods increases, the quantity supplied increases.
• When labor costs increase, the overall quantity supplied decreases.

These relationships between the determinants of demand and supply are examples of simple correlation. The usefulness stemming from this knowledge is limited. No one got rich by knowing that an increase in price leads to a decrease in quantity demanded.

Elasticity goes beyond simple correlation. Elasticity shows the magnitude of the change in both the determinant demand or supply (like price) and quantity demand or supply.