Economics

## Understanding the Supply Curve & How It Works

Learn about what a supply curve is, how a supply curve works, examples, and a quick overview of the law of demand and supply.

### Alejandro Diaz Herrera

Subject Matter Expert

Economics

04.23.2022 • 6 min read

Subject Matter Expert

The article explains what elasticity of demand is and what it means in economics. It also explains the different types and the main differences between elastic and inelastic demand.

In This Article

Elasticity of demand measures the responsiveness of demand to a change in some other factor in the market. For example, if the price of a product changes, the price elasticity of demand tells you how much demand will change in response to that price change.

Demand can either be elastic or inelastic. When demand is elastic, it is more sensitive to the changes it is being measured against. Inelastic goods are less sensitive to the changes they are being measured against.

In economics, there are different types of elasticities of demand. The ones you are most likely to encounter in undergraduate microeconomics and macroeconomics courses are:

Price elasticity of demand measures the percentage change in quantity demanded of a good relative to a percentage change in its price. It is also called own-price elasticity of demand, E$_{D}$ or PED. Price elasticity of demand is measured as the absolute value of the ratio of these two changes.

$E_{D} = | \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}}|$

Cross price elasticity of demand measures the percentage change in the quantity demanded of one good relative to a percentage change in the price of another good. It is also called XED.

$\text{XED} = \frac{\text{Percentage Change in Quantity Demanded of Good X}}{\text{Percentage Change in Price of Good Y}}$

Income elasticity of demand measures the percentage change in demand for a good relative to a percentage change in consumer incomes. It is also called E$_{I}$.

$E_{I} = \frac{\text{Percentage Change in Quantity Demanded }}{\text{Percentage Change in Consumer Income}}$

Elasticity can also be applied to the supply side of the market. For supply, you can measure:

The price elasticity of supply measures the percentage change in quantity supplied of a good relative to a percentage change in its price. It is also referred to as E$_{S}$.

$E_{S} = \frac{\text{Percentage Change in Quantity Supplied}}{\text{Percentage Change in Price}}$

The calculations for each type of elasticity are slightly different, but the intuition behind all elasticities is the same. In every case, elasticity measures the responsiveness of one factor—typically the quantity demanded or supplied of a good—relative to a percentage change in some other factor such as price or income.

Price elasticity of demand is closely related to the slope of the demand curve. In your very first economics course, you probably learned the law of demand, which states that consumers will demand a higher quantity of goods at cheaper prices, and a lower quantity of goods at higher prices. The law of demand explains why demand curves are downward sloping.

Price elasticity of demand is related to the steepness of the demand curve. It explains the extent to which demand changes when price increases or price decreases. The steeper the demand curve, the more inelastic demand is — meaning a small percentage change in price will not have a very big impact on the quantity demanded. The flatter the demand curve is, the more elastic demand is. When a demand curve is flat, even a small percentage change in price will have a large effect on quantity demanded

Because the price elasticity of demand is related to the slope of the demand curve, it’s easy to confuse the two, but the slope of the demand curve and the price elasticity of demand are not the same things. The slope of the demand curve is approximated by the change in price divided by the change in quantity. The price elasticity of demand is calculated as the percentage change in quantity divided by the percentage change in price!

Demand is elastic or inelastic, but economists further separate elasticity into five zones.

The measured value of elasticity is sometimes called the elasticity coefficient. When measured, the price elasticity of demand will have an elasticity coefficient greater than or equal to 0 and can be divided into five zones depending on the value of the coefficient.

PRICE ELASTICITY OF DEMAND | DESCRIPTION | ELASTICITY COEFFICIENT |

Perfectly Elastic Demand | Even a small change in price results in demand dropping to zero | Elasticity = ∞ |

Elastic Demand | A change in price results in a relatively large change in demand | Elasticity > 1 |

Unit Elastic Demand (also called unitary elasticity) | A change in price results in a proportional change in demand | Elasticity = 1 |

Inelastic Demand | A change in price results in a relatively small change in demand | Elasticity < 1 |

Perfectly Inelastic Demand | A change in price has no effect on demand. Price is not a determinant of demand | Elasticity = 0 |

The cross price elasticity of demand ranges from negative infinity to infinity and can also be divided into five zones of elasticity. The zones of elasticity can help you determine whether the two goods being compared are complements or substitutes.

CROSS PRICE ELASTICITY OF DEMAND | DESCRIPTION | ELASTICITY COEFFICIENT |

Perfectly Elastic Demand | The two goods being compared are perfect complements when XED = -∞ and perfect substitutes when XED = ∞ | Elasticity = -∞ or ∞ |

Elastic Demand | The two goods being compared are close complementary goods when XED < -1 and close substitute goods when XED > 1 | Elasticity < -1 or > 1 |

Unit Elastic Demand | The percent change in quantity demanded of Good X will be equal to the percent change in the price of Good Y | Elasticity = -1 or 1 |

Inelastic Demand | The two goods being compared are weak complements when -1< XED < 0 and weak substitutes when 0 < XED < 1 | -1 < Elasticity < 1 but not equal to 0 |

Perfectly Inelastic Demand | The two goods being compared are unrelated. Good Y’s price is not a determinant of Good X’s demand | Elasticity = 0 |

Like the cross price elasticity of demand, income elasticity can be positive or negative. The income effect tells us that demand for normal goods will increase as income increases and decrease when income decreases. The income effect also tells us that demand for inferior goods will decrease as income increases and increases as income decreases. Using the income effect and the income elasticity of demand, you can determine whether a good is a normal or inferior good.

INCOME ELASTICITY OF DEMAND | DESCRIPTION | ELASTICITY |

Negative Elasticity | An increase in income leads to a decrease in the quantity demanded, indicating that the good is an inferior good | Elasticity < 0 |

Inelastic Demand for Normal Goods | A percentage change in income will lead to a relatively small percentage change in quantity demanded. The good is a normal good and is likely to be a good that is a necessity | 0 < Elasticity < 1 |

Unit Elastic Demand for Normal Goods | A percentage change in income will lead to an equivalent percentage change in quantity demanded. The good is a normal good | Elasticity = 1 |

Elastic Demand for Normal Goods | A percentage change in income will lead to a relatively large change in the quantity demanded. The good is a normal good and is likely to be a luxury good | Elasticity > 1 |

Perfectly Inelastic Demand | Changes in income have no effect on quantity demanded. Income is not a determinant of demand | Elasticity = 0 |

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