Economics
Price Elasticity of Demand and Supply
Quick fact
When demand is inelastic, a price increase actually increases total revenue, even though fewer units are sold—which is why governments often tax goods like cigarettes and gasoline.
Why this is interesting
Ever wonder why a sudden price hike on your favorite snack makes you switch brands, but a steep rise in the price of insulin doesn't make you stop buying it? Why do some price changes dramatically alter buying behavior while others barely cause a ripple?
Read the full explanation
Understanding Price Elasticity of Demand and Supply
Price elasticity of demand and supply is a measure of how much the quantity demanded or supplied responds to a change in price. Think of it as a measure of 'sensitivity'—the more elastic, the more sensitive buyers or sellers are to price changes. For demand, if a 10% price increase leads to a 20% drop in quantity demanded, demand is elastic. If it only leads to a 2% drop, it's inelastic. For supply, elasticity reflects how easily producers can change output when prices change. For example, a farmer can quickly supply more strawberries if prices rise, but a factory producing specialized machinery may be limited in the short run.
A deeper explanation
Elasticity is calculated as the percentage change in quantity divided by the percentage change in price. The key factors determining demand elasticity are the availability of substitutes (more substitutes = more elastic), whether the good is a necessity or luxury (necessities are inelastic), the time horizon (demand is often more elastic in the long run as consumers adjust habits), and the share of income spent on the good. For supply, elasticity depends on production flexibility and time—supply is more elastic when firms can easily ramp up production. Elasticity matters because it determines who bears the burden of taxes (tax incidence), how total revenue changes with price, and how markets respond to shocks. For example, if demand is inelastic, a tax falls mostly on consumers; if elastic, producers bear more of it.