What is Elasticity?
- A Sensitivity Measure
- Measures impact on a criterion variable from changes in a managerial control variable
- A percentage computation
Elasticity = - DQ/Q / DP/P
Point Elasticity - Interpretation
- All computations can be interpreted as follows: An x% change in the criterion variable is associated with a 1% change in the control variable
- Classification of elasticity:
- Unitary (ED = 1)
- Elastic (ED = infinity perfectly elastic)
- Inelastic (ED = 0 perfectly inelastic)
Arc Elasticity = - (Q1 - Q2)/ 0.5(Q1 + Q2) / (P1 - P2)/ 0.5(P1 + P2)
Other Types of Elasticity:
- Income
- Advertising
- Cross elasticities
- In principle, an elasticity can be computed for any variable
- Managerially, we use business variables under our control
Conclusions
- Elasticity analysis is a sensitivity approach
- Price elasticities have relatively clear profit implications
- Other elasticities require a contribution analysis to interpret the impact on profit (i.e., change in revenue minus the increased cost of management change)
