Elasticity in microeconomics: what’s its role?

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Elasticity in microeconomics is a way of expressing how a change in the price of a given good will affect how much of that good consumers in the market will demand. Economists believe that a good is elastic if the change in its price, expressed as a percentage, is greater than the change in the quantity good consumers will ask for at that price, also expressed as a percentage. Knowledge of a good’s elasticity plays a useful role in estimating the sales impact of price changes for a given good.

What elasticity in microeconomics measures is the change in the amount consumers will ask for a given good from one price to another, not the overall demand for the good itself. In economics, the demand for a good is expressed in a graph, called a demand curve, which represents the quantity of a given good that consumers will demand at any given price. Changing the demand for a good, in the vocabulary of economics, is changing the quantity demanded at each price level. Elasticity in microeconomics measures changes in the quantity demanded or movements along the demand curve rather than changes in the demand curve itself.

If demand for a good is highly elastic, it means that firms can significantly change the quantity demanded of that good with a small change in price. The elasticity of demand for a good, calculated as the percentage change in price versus the percentage change in quantity demanded, works to describe both increasing quantity demanded and decreasing quantity demanded. For example, if the elasticity of demand for a good is highly elastic, a small increase in price will result in a large decline in the quantity demanded for that good. Likewise, a small drop in the price of the item will cause a large increase in the quantity demanded of that good.

When demand for a good is inelastic, firms can change the price of the item with a small change in the quantity demanded of that item. This means that companies can raise the price of an item without causing a significant reduction in the quantity required. It also means, however, that if the firm decreased the price of an item whose demand was inelastic, the quantity demanded of that item would not increase significantly.

Elasticity in microeconomics provides companies with data to guide their pricing decisions. If sales lag on a good with a high elasticity of demand, the company can reduce the price to increase the quantity required of that good so that sales become profitable again. Alternatively, if a company is losing money on a good whose elasticity of demand is very low, it knows that reducing its price will not increase sales; cutting prices would only exaggerate the company’s losses. In this situation, demand elasticity may tell a firm that to increase sales, it will need to change something about the nature of the product itself to shift the entire demand curve for the good upward, rather than simply decreasing the price of the good.

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