{"id":5161,"date":"2016-07-20T21:04:56","date_gmt":"2016-07-20T21:04:56","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/microeconomics\/?post_type=chapter&p=5161"},"modified":"2016-07-20T21:04:56","modified_gmt":"2016-07-20T21:04:56","slug":"reading-introduction-to-elasticity","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/atd-herkimer-microeconomics\/chapter\/reading-introduction-to-elasticity\/","title":{"raw":"Reading: Introduction to Elasticity","rendered":"Reading: Introduction to Elasticity"},"content":{"raw":"

[caption id=\"attachment_6396\" align=\"aligncenter\" width=\"599\"]\"Photo<\/a> Mr. Fantastic is elastic.[\/caption]\n\nThink about the word elastic<\/em>. It suggests that an item can be stretched. In economics, when we talk about\u00a0elasticity<\/strong>,<\/em>\u00a0we're referring to\u00a0how much something will stretch or change in response to another variable. Consider a rubber band, a leather strap, and a steel ring. If you pull on two sides\u00a0of a rubber band (or Mr. Fantastic), the force will cause it\u00a0to stretch a lot. If you use the same amount of force to pull on the ends of a leather strap, it will stretch somewhat, but not as much as the rubber band. If you pull on either side of a steel ring, applying the same amount of force, it probably won't stretch at all (unless you're very strong). Each of these materials (the rubber band, the leather strap, and the steel ring) displays\u00a0a different\u00a0amount of elasticity in response to being pulled, and all three fall somewhere on a continuum from very stretchy (elastic) to barely\u00a0stretchy (inelastic).\n\nThere are different kinds of economic elasticity\u2014for example, price elasticity of demand, price elasticity of supply, income elasticity of demand, and cross-price elasticity of demand\u2014but the underlying property is always the same: how responsive or sensitive one thing\u00a0is to a change in another thing.\n<\/p>

Elastic and Inelastic Demand<\/h2>\nLet's think about elasticity in the context of price and quantity demanded. We know from the law of demand that a rise in price will lead to a decrease in the quantity demanded. How much of a decrease? If a small change\u00a0in price creates\u00a0a large change in demand, then we would say that the demand is very elastic\u2014that is, the demand is very sensitive to a change in price. If, on the other hand, a large change in price results in a very small change in demand, then we would say the demand is inelastic.\u00a0Here's a\u00a0way to keep this\u00a0straight: Demand is in<\/strong>elastic when consumers are in<\/strong>sensitive to changes in price.\n\nConsider the example of cigarette taxes and smoking rates\u2014a classic example of inelastic demand. Cigarettes are taxed at both the state and federal level. As you might expect, the greater the amount of the tax increase, the fewer cigarettes are bought and consumed. Certain groups\u00a0of cigarette smokers, such as teenage, minority, low-income, and casual smokers, are somewhat\u00a0sensitive to changes in price: For every 10\u00a0percent increase in the price of a pack of cigarettes, the\u00a0smoking rates drop about 7\u00a0percent.\u00a0<\/span>Notice that the demand doesn't decrease as much as the price increase, though. We can say, then, that the demand for cigarettes\u2014at least among these groups\u2014is relatively inelastic. Addicted adult smokers are even less sensitive to changes in price\u2014most are willing to pay what it takes to support their smoking habit.\u00a0We can say that their demand is even more inelastic.\n\nYou might think that elasticity isn't an important consideration when it comes to the price of cigarettes. \u00a0Surely any<\/em> reduction in the demand for cigarettes would be a good thing, right? Does it really matter whether whether the demand is elastic or inelastic? It does. The reason is that taxes on cigarettes serve two purposes: to raise tax revenue for government and to discourage smoking. On one hand, if\u00a0a higher cigarette tax discourages consumption by quite a lot\u2014meaning a very large reduction in cigarette sales\u2014then the cigarette tax on each pack will not raise much revenue for the government. On the other hand, a higher cigarette tax that does not discourage consumption by much will actually raise more tax revenue for the government (but not have much impact on smoking rates). Thus, when Congress tries to calculate the effects of altering its cigarette tax, it must analyze how much<\/em> the tax affects the quantity of cigarettes consumed. In other words, understanding the elasticity of cigarette demand is key to measuring\u00a0the\u00a0impact of taxes on government revenue AND public health.\n\nThis issue reaches beyond governments and taxes; every firm faces a similar challenge. Every time a firm considers raising the price that it charges, it needs to know how much a price increase will reduce the quantity of its product that is demanded. Conversely, when a firm puts its products on sale, it wants assurance that the lower price will lead to a significantly higher quantity demanded.\n\n[caption id=\"attachment_6397\" align=\"aligncenter\" width=\"500\"]\"Photo<\/a> Mr. Fox is inelastic.[\/caption]","rendered":"

\"Photo<\/a><\/p>\n

Mr. Fantastic is elastic.<\/p>\n<\/div>\n

Think about the word elastic<\/em>. It suggests that an item can be stretched. In economics, when we talk about\u00a0elasticity<\/strong>,<\/em>\u00a0we’re referring to\u00a0how much something will stretch or change in response to another variable. Consider a rubber band, a leather strap, and a steel ring. If you pull on two sides\u00a0of a rubber band (or Mr. Fantastic), the force will cause it\u00a0to stretch a lot. If you use the same amount of force to pull on the ends of a leather strap, it will stretch somewhat, but not as much as the rubber band. If you pull on either side of a steel ring, applying the same amount of force, it probably won’t stretch at all (unless you’re very strong). Each of these materials (the rubber band, the leather strap, and the steel ring) displays\u00a0a different\u00a0amount of elasticity in response to being pulled, and all three fall somewhere on a continuum from very stretchy (elastic) to barely\u00a0stretchy (inelastic).<\/p>\n

There are different kinds of economic elasticity\u2014for example, price elasticity of demand, price elasticity of supply, income elasticity of demand, and cross-price elasticity of demand\u2014but the underlying property is always the same: how responsive or sensitive one thing\u00a0is to a change in another thing.\n<\/p>\n

Elastic and Inelastic Demand<\/h2>\n

Let’s think about elasticity in the context of price and quantity demanded. We know from the law of demand that a rise in price will lead to a decrease in the quantity demanded. How much of a decrease? If a small change\u00a0in price creates\u00a0a large change in demand, then we would say that the demand is very elastic\u2014that is, the demand is very sensitive to a change in price. If, on the other hand, a large change in price results in a very small change in demand, then we would say the demand is inelastic.\u00a0Here’s a\u00a0way to keep this\u00a0straight: Demand is in<\/strong>elastic when consumers are in<\/strong>sensitive to changes in price.<\/p>\n

Consider the example of cigarette taxes and smoking rates\u2014a classic example of inelastic demand. Cigarettes are taxed at both the state and federal level. As you might expect, the greater the amount of the tax increase, the fewer cigarettes are bought and consumed. Certain groups\u00a0of cigarette smokers, such as teenage, minority, low-income, and casual smokers, are somewhat\u00a0sensitive to changes in price: For every 10\u00a0percent increase in the price of a pack of cigarettes, the\u00a0smoking rates drop about 7\u00a0percent.\u00a0<\/span>Notice that the demand doesn’t decrease as much as the price increase, though. We can say, then, that the demand for cigarettes\u2014at least among these groups\u2014is relatively inelastic. Addicted adult smokers are even less sensitive to changes in price\u2014most are willing to pay what it takes to support their smoking habit.\u00a0We can say that their demand is even more inelastic.<\/p>\n

You might think that elasticity isn’t an important consideration when it comes to the price of cigarettes. \u00a0Surely any<\/em> reduction in the demand for cigarettes would be a good thing, right? Does it really matter whether whether the demand is elastic or inelastic? It does. The reason is that taxes on cigarettes serve two purposes: to raise tax revenue for government and to discourage smoking. On one hand, if\u00a0a higher cigarette tax discourages consumption by quite a lot\u2014meaning a very large reduction in cigarette sales\u2014then the cigarette tax on each pack will not raise much revenue for the government. On the other hand, a higher cigarette tax that does not discourage consumption by much will actually raise more tax revenue for the government (but not have much impact on smoking rates). Thus, when Congress tries to calculate the effects of altering its cigarette tax, it must analyze how much<\/em> the tax affects the quantity of cigarettes consumed. In other words, understanding the elasticity of cigarette demand is key to measuring\u00a0the\u00a0impact of taxes on government revenue AND public health.<\/p>\n

This issue reaches beyond governments and taxes; every firm faces a similar challenge. Every time a firm considers raising the price that it charges, it needs to know how much a price increase will reduce the quantity of its product that is demanded. Conversely, when a firm puts its products on sale, it wants assurance that the lower price will lead to a significantly higher quantity demanded.<\/p>\n

\"Photo<\/a><\/p>\n

Mr. Fox is inelastic.<\/p>\n<\/div>\n\n\t\t\t

\n\t\t\t

Candela Citations<\/h3>\n\t\t\t\t\t
\n\t\t\t\t\t\t
\n\t\t\t\t\t\t\t
CC licensed content, Original<\/div>