Elasticity: Types, Factors, Applications & Real-World Impact

Core Concepts

1. What is Elasticity?

Elasticity measures how responsive quantity demanded or supplied is to changes in price, income, or related goods. It is a percentage change, not absolute change, making it comparable across markets.

Key Idea: Elasticity helps businesses and governments predict how consumers/producers will react to changes (e.g., price hikes, subsidies, or new products).

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2. Price Elasticity of Demand (PED)

Definition: $$\text{PED}=\frac{\%\text{ Change in Quantity Demanded}}{\%\text{ Change in Price}}$$

• Elastic Demand ($|PED|>1$): Quantity changes more than price (e.g., luxury goods).
• Inelastic Demand ($|PED|<1$): Quantity changes less than price (e.g., salt, medicine).
• Unitary Elastic ($|PED|=1$): Proportional change (e.g., some agricultural products).

Factors Affecting PED

Worked Example: Ncell Prepaid Plans

• Scenario: Ncell increases prepaid recharge price by 10% (from Rs. 100 to Rs. 110).
• Data:
  • Initial quantity demanded: 10,000 recharges/day.
  • New quantity demanded: 9,000 recharges/day.
• Calculation: $$\%\Delta Q=\frac{9000-10000}{10000}\times 100=-10\%$$ $$\%\Delta P=\frac{110-100}{100}\times 100=+10\%$$ $$\text{PED}=\frac{-10\%}{+10\%}=-1(\text{Unitary Elastic})$$
• Interpretation: For every 1% price increase, demand falls by 1%. Ncell’s revenue remains unchanged if demand is unitary elastic.

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3. Price Elasticity of Supply (PES)

Definition: $$\text{PES}=\frac{\%\text{ Change in Quantity Supplied}}{\%\text{ Change in Price}}$$

• Elastic Supply ($|PES|>1$): Producers can easily increase supply (e.g., manufactured goods).
• Inelastic Supply ($|PES|<1$): Supply is hard to change (e.g., agricultural crops, concert tickets).

Factors Affecting PES

Worked Example: Daraz’s Supply Chain

• Scenario: Daraz increases the price of a smartphone by 15% due to import costs.
• Data:
  • Initial supply: 500 units/week.
  • New supply: 650 units/week (suppliers ramp up production).
• Calculation: $$\%\Delta Q=\frac{650-500}{500}\times 100=+30\%$$ $$\%\Delta P=+15\%$$ $$\text{PES}=\frac{+30\%}{+15\%}=2(\text{Elastic Supply})$$
• Interpretation: Daraz can increase supply by 2% for every 1% price rise, making it profitable to raise prices during high demand (e.g., festive season).

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In the Real World

1. eSewa & Transaction Fees
   • Idea Used: Price Elasticity of Demand (PED)
   • How? eSewa charges a flat fee (Rs. 25) for transactions up to Rs. 10,000. For larger amounts, the fee becomes a percentage (0.5%), making high-value transactions more elastic (users seek alternatives like Khalti or bank transfers).
   • Why? If eSewa raises fees, users with many small transactions (inelastic) will pay, but those with large payments (elastic) may switch.

2. NTC’s Internet Pricing Strategy

   • Idea Used: Income Elasticity of Demand (YED)
   • How? NTC offers discounted plans for students (low-income, income-elastic demand) while charging premium prices for businesses (high-income, inelastic demand).
   • Data: A 10% income rise for students increases internet demand by 15% (YED = +1.5), but for corporations, demand rises only 5% (YED = +0.5).

3. Pathao’s Surge Pricing During Traffic

   • Idea Used: Price Elasticity of Supply (PES) & Demand (PED)
   • How? During Kathmandu traffic jams (e.g., Thamel to Kantipath), Pathao dynamically increases fares. Drivers (supply) cannot instantly increase trips (inelastic supply), but riders reduce demand if prices rise too much (elastic demand).
   • Result: Pathao balances revenue maximization (higher prices) with driver availability (limited supply).

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4. Income Elasticity of Demand (YED)

Definition: $$\text{YED}=\frac{\%\text{ Change in Quantity Demanded}}{\%\text{ Change in Income}}$$

• Normal Goods (YED > 0): Demand rises with income (e.g., organic food, smartphones).
• Inferior Goods (YED < 0): Demand falls with income (e.g., public transport, cheap noodles).
• Luxury Goods (YED > 1): Demand rises more than proportionally (e.g., vacations, designer clothes).

Worked Example: Nepal’s Remittance-Driven Demand

• Scenario: Nepal’s GDP grows by 5% (due to remittances), increasing average income by 3%.
• Data:
  • Initial demand for organic vegetables: 1,000 kg/month.
  • New demand: 1,150 kg/month.
• Calculation: $$\%\Delta Q=\frac{1150-1000}{1000}\times 100=+15\%$$ $$\%\Delta Y=+3\%$$ $$\text{YED}=\frac{+15\%}{+3\%}=+5(\text{Luxury Good})$$
• Interpretation: Organic vegetables are a luxury in Nepal—demand rises 5x faster than income.

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5. Cross Elasticity of Demand (XED)

Definition: $$\text{XED}=\frac{\%\text{ Change in Quantity Demanded of Good A}}{\%\text{ Change in Price of Good B}}$$

• Substitutes (XED > 0): Price of Good B ↑ → Demand for Good A ↑ (e.g., Coca-Cola vs. Fanta).
• Complements (XED < 0): Price of Good B ↑ → Demand for Good A ↓ (e.g., cars and petrol).
• Unrelated Goods (XED ≈ 0): No relationship (e.g., bread and laptops).

Worked Example: Daraz vs. Local Shops

• Scenario: Daraz increases the price of iPhones by 20%.
• Data:
  • Initial demand for Samsung phones (substitute): 500 units/month.
  • New demand: 700 units/month (consumers switch).
• Calculation: $$\%\Delta Q_{\text{Samsung}}=\frac{700-500}{500}\times 100=+40\%$$ $$\%\Delta P_{\text{iPhone}}=+20\%$$ $$\text{XED}=\frac{+40\%}{+20\%}=+2(\text{Strong Substitutes})$$
• Interpretation: Daraz and local shops compete fiercely—a price hike on one brand doubles demand for substitutes.

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Exam Tip

1. Always State the Formula First

   • Examiners deduct marks if you skip the formula. Example:

     "The Price Elasticity of Demand is calculated as: $\text{PED}=\frac{\%\Delta Q}{\%\Delta P}$."

2. Use Real Numbers

   • Avoid vague answers. For example:
     • ❌ "Demand is elastic."
     • ✅ "If NTC raises internet prices by 10% and demand falls by 15%, PED = –1.5, indicating elastic demand."

3. Compare with Graphs

   • Draw demand/supply curves and label elastic/inelastic regions. Example:

4. Link to Policy/Business Decisions

   • Questions often ask: "Should the government tax cigarettes?"
   • Answer: *"Cigarettes have inelastic demand (PED < 1). A tax increase raises revenue but discourages consumption less. However, health benefits justify it."*

5. Watch for Tricks

   • Income vs. Price Elasticity: Don’t confuse YED and PED. Example:
     • *"If income rises and demand for public transport falls, it’s an inferior good (YED < 0)—not about price!"*

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Final Reminder: Elasticity is not about absolute changes but percentage changes. Always calculate both numerator and denominator separately!