Application Of Elasticity

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Elasticity is the ratio of the percent change in one variable to the percent change in another variable. It is a tool for measuring the responsiveness of a function to changes in parameters in a unit-less way. Frequently used elasticities include price elasticity of demand, price elasticity of supply, income elasticity of demand, elasticity of substitution between factors of production and elasticity of intertemporal substitution.
Elasticity is one of the most important concepts in economic theory. It is useful in understanding the incidence of indirect taxation, marginal concepts as they relate to the theory of the firm, and distribution of wealth and different types of goods as they relate to the theory of consumer choice. Elasticity is also crucially important in any discussion of welfare distribution, in particular consumer surplus, producer surplus, or government surplus.
In empirical work an elasticity is the estimated coefficient in a linear regression equation where both the dependent variable and the independent variable are in natural logs. Elasticity is a popular tool among empiricists because it is independent of units and thus simplifies data analysis.
Generally, an "elastic" variable is one which responds "a lot" to small changes in other parameters. Similarly, an "inelastic" variable describes one which does not change much in response to changes in other parameters. A major study of the price elasticity of supply and the price elasticity of demand for US products was undertaken by Hendrik S. Houthakker and Lester D. Taylor
The concept of elasticity has an extraordinarily wide range of applications in economics. In particular, an understanding of elasticity is fundamental in understanding the response of supply and demand in a market.
Some common uses of elasticity include:
•Effect of changing price on firm revenue. See Markup rule.
•Analysis of incidence of the tax burden and other government policies. See Tax incidence.
•Income elasticity of demand can be used as an indicator of industry health and as a guide to firms investment decisions. See Income elasticity of demand.
•Effect of international trade and terms of trade effects. See MarshallLerner Condition and SingerPrebisch thesis.
•Analysis of consumption and saving behavior. See Permanent income hypothesis.
•Analysis of advertising on consumer demand for particular goods. See Advertising elasticity of demand

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