Figure 4 - Income Elasticities Visualised
Cross price elasticity
Sometimes it is useful to understand how the quantity demanded for a product will change if the price for another product changes. For example, what would happen to the quantity demanded for cars if the price for petrol increases? In simple terms, Cross Price Elasticity (XED) is the responsiveness in the quantity demanded of one good when the price for another good changes. Similar to YED, when Cross Price Elasticity is calculated, the pair of goods analysed receives a category: they can be complements, substitutes or unrelated products.
Figure 5 - Cross Price Elasticities Visualised
Applications and examples of elasticity
The concept of elasticity is extremely helpful for companies to understand how consumers react to changes in the market. Indeed, elasticity metrics can be a useful guideline during the strategic decision-making of organisations. For example, beer is relatively price inelastic, meaning that consumer demand will respond slightly to a price change. Beer producers may therefore be inclined to increase their prices to benefit from higher profits. Of course, these elasticity metrics vary from country to country, depending on the consumption habits of different people. The US Economic Research Service keeps a database with the PED of all product categories for each country in the world.
Equally, the concept of elasticity can communicate important information to consumers. For example, rental housing in London is known to be of inelastic supply (PES). This means that even if the price of housing increases, there will be a very small increase in the supply of houses in the market. The housing crisis in the UK is arguably the root cause of this inelasticity, which makes it difficult to find any new land to supply for housing. Therefore, someone that is looking to move to London may keep this supply inelasticity in mind before jumping into home hunting.
Closing thoughts
Overall, elasticity is an economic metric that looks to understand how sensitive some variables are in response to changes in others. The most commonly used type of elasticity is the Price Elasticity of Demand (PED). It takes the Law of Demand one step further to understand how much a change in price can affect the quantity demanded in a market. It is important to remember that different elasticity values mean different things. However, generally speaking when a product is elastic, its demand is responsive to changes in price. These goods tend to be products we can go without such as luxury goods. On the other hand, when a product is inelastic, it is not responsive to changes in price. These goods tend to be commodities or necessities; products we cannot live without. Other types of elasticity such as Price Elasticity of Supply (PES), Income Elasticity (YED) or Cross Price Elasticity (XED) provide organisations and consumers with extremely valuable information that feeds into their decision-making processes.
Further reading
To read more of Greenlaw’s Economics Textbooks, read ‘Principles of Economics’
To find out more about how economic principles such as elasticity affect the decision-making of organisations and consumers, read ‘The Five Life Decisions: How Economic Principles and 18 Million Millennials Can Guide Your Thinking’
To find out more about the criticisms and limitations of elasticity, read ‘The Economics Anti-Textbook: A Critical Thinker's Guide to Microeconomics’