What Is the Role of Elasticity in Microeconomics?

Elasticity in microeconomics is a way of expressing how a change in the price of a given good will affect the quantity of that good which consumers in the market will demand. Economists consider a good to be elastic if the change in its price, expressed as a percentage, is is greater than the change in the quantity of the good consumers will demand at that price, also expressed as a percentage. Knowledge about a good's elasticity plays a useful role in estimating the sales impact of price changes for a given good.

What elasticity in microeconomics measures is the change in the quantity that consumers will demand of a given good from price to price, not the overall demand for the good itself. In economics, the demand for a good is expressed as a graph, called the demand curve, that represents the quantity of a given good that consumers will demand at every price. To change the demand for a good, in the vocabulary of economics, is to change the quantity demanded at each price level. Elasticity in microeconomics measures changes in quantity demanded, or movements along the demand curve instead of shifts in the demand curve itself.

If the demand for a good is highly elastic, then it means that companies can significantly change the quantity demanded of that good with a small change in the price. The elasticity of demand for a good, calculated as the percent change in price over the percent change in quantity demanded, works to describe both increasing quantity demanded and decreasing quantity demanded. For example, if a good's elasticity of demand is highly elastic, then a small increase in price will cause a large drop in the quantity demanded for that good. Similarly, a small drop in the item's price will cause a large rise in the quantity demanded for that good.

When the demand for a good is inelastic, then companies can change the price of the item with little change in the quantity demanded of that item. This means that firms can increase the price of an item without causing a significant decrease in quantity demanded. It also means, however, that if the firm decreased the price of an item whose demand was inelastic, the quantity demanded for that item would not significantly increase.

Elasticity in microeconomics gives companies data to guide their pricing decisions. If sales are lagging on a good with a high elasticity of demand, then the company can decrease the price to raise the quantity demanded for that good so that sales will once again become profitable. Alternatively, if a company is losing money on a good whose elasticity of demand is very low, it knows that decreasing the price will not increase sales; decreasing prices would only exaggerate the company's losses. In this situation, elasticity of demand can tell a company that to increase sales, it will have to change something about the nature of the product itself to shift the entire demand curve for the good upward, rather than just decreasing the price of the good.