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Elasticity

Elasticity answers a simple question: when price changes, how much does quantity respond? It turns the shape of a curve into a number you can reason with.

Price elasticity of demand

Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. If a 10% price rise cuts quantity by 20%, elasticity is 2 — demand is elastic. If quantity barely moves, demand is inelastic. Necessities tend to be inelastic; luxuries and goods with close substitutes tend to be elastic.

Why it drives revenue

Total revenue is price times quantity, and elasticity tells you which wins when they move in opposite directions:

• When demand is elastic, cutting price raises revenue (the quantity gain outweighs the lower price).
• When demand is inelastic, raising price raises revenue (buyers stick around).
• At unit elasticity, revenue is at its peak and small price changes barely move it.

Elasticity of supply

Supply has its own elasticity: how much producers change output when price moves. It depends mostly on time and flexibility — supply is more elastic when firms can easily add capacity or switch inputs, and more inelastic in the short run.

Tax incidence

Elasticity decides who really pays a tax. The more inelastic side of the market bears the larger share, because it has fewer ways to escape the price change. A tax on a good with very inelastic demand falls mostly on buyers, regardless of who legally writes the check.

Common exam traps

• Reading elasticity off the slope alone — it also depends on where you are on the curve.
• Forgetting elasticity is usually reported as an absolute value for demand.
• Assuming the party a tax is "placed on" is the party who bears it.

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