Understanding Elasticity in Microeconomics

In the previous segments, you learnt how demand and supply change with changes in the various factors that affect them. In this segment, you will learn how to measure the degree of sensitivity of the demand or the supply curve to consumer choice. In other words, this segment will introduce you to the concept of elasticity.

Elasticity is an essential concept in economics. It helps in understanding how goods and services are able to adapt to changes in price. 

Now, in the upcoming video, you will listen to Chris as he shares his thoughts on how elasticity affects the demand for and the supply of a product. 

So, in the video, you learnt about the concept of demand elasticity. An elastic good has a relatively steeper demand curve, whereas an inelastic good has a relatively flatter demand curve.

A great example, and application, of the price elasticity of demand, is the travel industry. While booking flights, you would have noticed that as the date of the journey comes closer, the price of the tickets become steeper. As flight tickets can be booked months in advance, it would be common practice to book tickets at least a month before the scheduled travel. So, it is expected that customers whose date of journey is close to their booking date are in a dire need for travel. They are willing to spend more on their ticket to undertake the journey.

In fact, the airline industry uses price elasticity of demand as a means to classify its customer base. For each set of customers with a similar price elasticity of demand, different prices are quoted as per their willingness to pay. Although you will learn more about such phenomena in a later section on price discrimination, it is important to note that the price elasticity of demand enables producers to undertake price discrimination.

In the video, you also learnt that the price elasticity of demand is calculated by dividing the percentage change in quantity demanded by the percentage change in price.

Now, let’s move on to the concept of elasticity of supply and learn about it from Chris in the next video.

So, in the video, you learnt that an elastic good has a steep supply curve, whereas an inelastic good has a supply curve that is relatively less steep.

We can also extend the formula introduced by Chris in the video to calculate the price elasticity of supply as well. Price elasticity of supply is calculated by dividing the percentage change in quantity supplied by the percentage change in price. 

An example of a perfectly inelastic supply is the hotel industry. Consider a hotel located in a remote city. Say there is a movie shoot of a famous star planned in the city and suddenly, there is a huge demand for hotels as fans of the star land up in the city for as long as the shoot lasts. So, you would expect the price of the average hotel room in the city to rise due to the sudden shift in demand. Although hotels would match their price with the expected price, they would not be able to "supply" more rooms, as their capacities are limited. If a hotel has 100 rooms, it cannot utilise more than 100 rooms on any day, regardless of the demand or price.

Additional Learning

• This article will help you gain further understanding of how to calculate the price elasticity of demand and supply.
• This simulated graph demonstrates how a straight-line demand curve displays varying degrees of elasticity at different points on the graph.
• In many markets, having an elastic supply is essential for quickly responding to the market and gaining more market share in the process. Here is a research paper on how Airbnb's supply elasticity and policy changes on hosting costs severely affected the competitive dynamics in the hospitality industry.