We know that when the price of a coffee goes up, the quantity demanded usually goes down. But by how much? A little? A lot? This question of 'how much' is crucial for businesses setting prices and for governments predicting the impact of taxes. Economists use the concept of elasticity to measure this responsiveness.

Let's start with the most common type: price elasticity of demand (PED). It tells us the percentage change in quantity demanded resulting from a one percent change in price. The basic formula is:

A simple percentage change calculation can be misleading because the result depends on your starting point. If a price moves from $10 to $12, that's a 20% increase. But a fall from $12 to $10 is only a 16.7% decrease. To avoid this ambiguity, economists use the midpoint method for a more precise calculation.

The value of elasticity tells us a story about consumer behaviour.

For a business, understanding this is vital for pricing strategy. The relationship between elasticity and total revenue (Price × Quantity) is called the total revenue test.

Elasticity isn't just about the direct relationship between a good's price and its demand. We can also measure how demand shifts due to other factors.

Cross-Price Elasticity of Demand ($E_{xy}$) measures how the quantity demanded of one good (X) responds to a change in the price of another good (Y).

• If $E_{xy} > 0$, the goods are substitutes. When the price of coffee goes up, the quantity of tea demanded increases.
• If $E_{xy} < 0$, the goods are complements. When the price of printers goes up, the quantity of ink cartridges demanded falls.

Income Elasticity of Demand ($E_I$) measures how quantity demanded responds to a change in consumer income.

• If $E_I > 0$, it's a normal good. As income rises, people buy more of it.
• If $E_I < 0$, it's an inferior good. As income rises, people buy less of it (e.g., switching from instant noodles to restaurant meals).

Finally, the Price Elasticity of Supply ($E_s$) measures how the quantity supplied responds to a change in price. Its calculation is analogous to PED. Supply is more elastic if producers can easily change their production levels. For example, the supply of factory-made t-shirts is more elastic than the supply of beachfront properties.

Elasticity directly determines tax incidence—the division of a tax burden between buyers and sellers. It's not about who physically hands the money to the government. It's about who feels the economic pain.

The rule is simple: the burden of a tax falls more heavily on the side of the market that is less elastic (less responsive to price changes).

If demand is inelastic (like for petrol), consumers have few alternatives and can't easily reduce their consumption. They end up paying most of the tax. If demand is elastic (like for a specific brand of fizzy drink), consumers can easily switch to another brand if the price rises. The producer can't pass on the tax and must absorb the cost, bearing most of the burden.

Elasticity is more than a theoretical tool. It is a practical concept that explains pricing power, consumer choice, and the real-world consequences of economic policy.