Elasticity Types
Price
→Income
→Cross
→Apply
In This Article
Introduction
Elasticity measures responsiveness—how much one variable changes in response to a change in another. Understanding elasticity is crucial for pricing decisions, revenue management, and market analysis.
Price Elasticity of Demand (PED)
PED = % Change in Quantity Demanded / % Change in Price
PED = (ΔQ/Q) / (ΔP/P)
| Elasticity | Value | Revenue Effect of Price Increase |
|---|---|---|
| Elastic | |PED| > 1 | Revenue decreases |
| Unit Elastic | |PED| = 1 | Revenue unchanged |
| Inelastic | |PED| < 1 | Revenue increases |
| Perfectly Elastic | |PED| = ∞ | Lose all sales |
| Perfectly Inelastic | |PED| = 0 | No quantity change |
Key Insight: PED is usually negative (law of demand), but we often use absolute values for comparison.
Income Elasticity of Demand (YED)
YED = % Change in Quantity / % Change in Income
| Type | YED Value | Examples |
|---|---|---|
| Normal Goods | YED > 0 | Most goods |
| Necessity | 0 < YED < 1 | Food, utilities |
| Luxury | YED > 1 | Vacations, jewelry |
| Inferior Goods | YED < 0 | Budget brands, public transport |
Cross-Price Elasticity of Demand (XED)
XED = % Change in Quantity of Good A / % Change in Price of Good B
| Relationship | XED Value | Examples |
|---|---|---|
| Substitutes | XED > 0 | Coke/Pepsi, butter/margarine |
| Complements | XED < 0 | Cars/petrol, phones/apps |
| Unrelated | XED = 0 | Shoes/bread |
Determinants of Price Elasticity
- Availability of substitutes: More substitutes = more elastic
- Necessity vs luxury: Necessities are inelastic
- Proportion of income: Higher proportion = more elastic
- Time horizon: Longer time = more elastic
- Brand loyalty: Strong loyalty = inelastic
- Habit-forming: Addictive goods are inelastic
Business Applications
- Pricing strategy: Raise price on inelastic goods; lower on elastic
- Revenue management: Use elasticity to maximize total revenue
- Market segmentation: Different prices for segments with different elasticities
- Tax incidence: Inelastic goods bear more tax burden
- Competitive analysis: High XED indicates direct competitors
Conclusion
Key Takeaways
- Price elasticity measures quantity response to price changes
- Elastic (>1): Price ↑ → Revenue ↓; Inelastic (<1): Price ↑ → Revenue ↑
- Income elasticity distinguishes normal, luxury, and inferior goods
- Cross elasticity identifies substitutes (+) and complements (-)
- Key determinants: substitutes, necessity, income proportion, time
- Use elasticity for pricing, segmentation, and competitive analysis