Elasticity

Elasticity measures how sensitive demand or supply is to a change in price.

It answers: "If price changes by 10%, by how much will quantity change?"

1. Price Elasticity of Demand (PED)

Formula: PED = % Change in Quantity Demanded / % Change in Price

A. Elastic Demand (PED > 1)

Meaning: Demand is very sensitive to price changes.

Example: Luxury cars, international vacations.

• Mercedes price increases by 10% → Demand falls by 20%.
• PED = 20/10 = 2 (Elastic).

B. Inelastic Demand (PED < 1)

Meaning: Demand is NOT sensitive to price changes.

Example: Salt, medicines, petrol.

• Salt price increases by 10% → Demand falls by 2%.
• PED = 2/10 = 0.2 (Inelastic).

C. Unitary Elastic (PED = 1)

Demand changes by exactly the same % as price.

2. Why Does Elasticity Matter?

For Businesses:

• Elastic Product: Don't increase price (You'll lose customers).
• Inelastic Product: You can increase price (Revenue will increase).

Example:

• Apple knows iPhones are relatively inelastic (Brand loyalty). They can charge ₹1.5 Lakhs.
• Generic Salt is elastic. If one brand increases price, people switch to another.

For Government:

• Tax on Inelastic Goods (Petrol, Cigarettes) → Revenue increases (People still buy despite high price).
• Tax on Elastic Goods (Luxury cars) → Revenue may fall (People stop buying).

3. Factors Affecting Elasticity

1. Availability of Substitutes:

   • Many substitutes → Elastic (Android for iPhone).
   • No substitutes → Inelastic (Life-saving medicine).

2. Necessity vs Luxury:

   • Necessity → Inelastic (Insulin for diabetics).
   • Luxury → Elastic (Designer clothes).

3. Time:

   • Short-run: Inelastic (You need petrol today).
   • Long-run: Elastic (You switch to an electric car).

4. Proportion of Income:

   • Small portion of income → Inelastic (Matchbox).
   • Large portion → Elastic (House).

4. Real-Life Examples

A. Netflix Price Hike

• Netflix increases subscription from ₹199 to ₹249.
• Some users cancel (Elastic for them).
• Loyal viewers continue (Inelastic).
• Overall: Moderately Elastic.

B. Water vs Diamond Paradox

• Water (Essential): Cheap, but inelastic.
• Diamond (Luxury): Expensive, but elastic (People can delay buying).

Why? Scarcity + Marginal Utility.

5. Income Elasticity of Demand

Formula: YED = % Change in Quantity Demanded / % Change in Income

• Normal Goods (YED > 0): Demand increases as income increases (Cars, Eating out).
• Inferior Goods (YED < 0): Demand decreases as income increases (Low-quality rice, Public transport).

7-Day Action Plan

Day 1: Pick 5 products you buy. Rate them as Elastic or Inelastic.
Day 2: Check fuel prices over the last 6 months. Did consumption change much? (Hint: Inelastic).
Day 3: Read about "Sin Taxes" (High tax on alcohol, tobacco). Why does Govt tax inelastic goods?
Day 4: Look at OTT subscriptions. Which one would you cancel first if all increased price by 20%? (That's your most elastic one).
Day 5: Understand cross-elasticity. If Petrol price increases, demand for Electric Vehicles increases (Substitutes).
Day 6: Calculate PED for a hypothetical product. Price ₹100 → ₹110 (10% increase). Demand 1000 → 800 (20% decrease). PED = 2.
Day 7: Think about your own salary. If your income increases 20%, what will you buy more of? (Normal Goods). What will you stop buying? (Inferior Goods).

Quiz

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💡 Final Wisdom: Elasticity is the reason iPhones are expensive and salt is cheap. It's all about leverage.