What is Elasticity?
Elasticity measures the sensitivity of change of one variable in response to another, causal variable. We call variables that respond drastically to change as ‘elastic’, and ones that don’t respond a lot as ‘inelastic’.
How do we calculate elasticity? Let’s steal a page from your high school Econ 101 textbook. You can calculate the elasticity of a variable by dividing the percentage change in quantity by the percentage change in price.
Examples of Elasticity
Imagine you’re the owner of a high-tech pizza delivery startup. Your competitive advantage? All your pizzas reach customers at the peak of freshness because they’re quickly delivered by AI-powered drones!
You originally charged $10 per drone-delivered pizza, and business stays steady at 100 pizzas ordered a week, but after a few months you realize your operating costs are higher than you anticipated. In response, you raise the price to $11 per pizza, but - suddenly! - orders plummet to 50 pizzas per week. Plugging in the numerical changes into the formula above, you get the following result:
% change in quantity = (50 pizza orders - 100 pizza orders)/100 pizza orders = -.5 => -50%
% change in price = ($11-$10)/$10 = .1 => 10%
-50%/10% = |-5| = 5
In general, we consider products with scores greater than 1 as highly elastic. It looks like pizza delivery powered by AI-driven drones is a highly elastic service and (sadly for you) raising prices won’t cover your costs.
Of course, the concept of elasticity isn’t limited to understanding economic theory (or Chapter 1 of your high school economics textbook.) Simply put, elasticity models change, which means you can use it to understand the relationship between any two variables!
If you’re a teacher, the belief you have in your students will affect their performance. In fact, economist, Tyler Cowen, references an educational research paper that suggests an elastic relationship between teacher expectations and college completion among their students. The paper concluded that, in general, overestimating student abilities, while inaccurate, increased overall student success.
Well, what do you know? Optimism really does pay off!
Also check out
Teacher Expectations Matter Marginal Revolution, Tyler Cowen
The elasticity of trust in the Middle East Marginal Revolution, Tyler Cowen