Kids love rubber bands. However far you stretch them, they always bounce back (unless you go past their limits and they snap!). This is because they have high elasticity.
A kind of rubber band exists in the financial world too, called “elasticity.” It describes the amount that people’s behavior changes (i.e., becomes more or less elastic), in reaction to a price change for a good or service. When a good is elastic, people quickly change their demand for it as the price changes. When a product is not flexible (called inelastic), people likely won’t change their request when the price changes.
Elasticity refers to how flexible the price of a product is when other external factors are influencing it. For example, when a Snickers chocolate bar’s price will significantly rise in a short time, then most likely the consumer’s demand for that chocolate bar will decrease.
Knowing this, we can conclude that for every percentage point that the price of the chocolate bar increases, the consumer’s rate of purchase will decrease. Therefore, the cost of the chocolate bar is said to be very elastic.
The importance of elasticity
If you are studying economic theory, flexibility is one of the most important concepts in economics. For instance, it is beneficial when dealing with the idea of indirect taxation. If you increase the tariff for oil, how much will food cost increase since the distribution from farms to market need fuel? The answer is a lot, primarily if the farms are located far from the restaurants and retail stores.
But in the financial world, elasticity also is significant. If the demand for a product will change by a huge percentage when the price only varies a little, then the need for the product is classified as too elastic for analysts. These analysts then publish a report, which can discourage future investors who prefer stability.
Elasticity for non-consumers
For non-consumers, elasticity is considered an economic measure. Since elasticity determines the rate of how consumers buy the products or services in correlation with their prices, then it plays a huge role for the sellers.
On the other hand, if the product is classified as inelastic, then most likely sellers would like that product less, which may result in businesses producing less quantity of that product. In worse and desperate cases, they may decrease the price of the product for it to be sold to consumers.
Elasticity for consumers
As someone who is taking care of his or her money, consumers would also be wise to look at the elasticity of products. Consumers must be quick to notice when a product or service will be considered as elastic.