Cora and I are back onto the economic exercises this week, and in this article we'll talk about economic elasticity. Elasticity is an appropriate word to use in this case, because it describes the way that demand and supply reacts to changes in price. How does it react? Well, supply and demand can become rubbery and flexible as well as rigid. Think rubber bands.

As we mentioned in a previous article, supply represents how much a market can offer. Demand, on the other hand, refers to how much buyers desire a product or service. Some products that are necessities (like bread) are more insensitive to price changes because consumers would continue buying these products despite price increases. Conversely, a price increase of a good or service that is considered less of a necessity (like wine) will deter more consumers because the opportunity cost of buying the product will become too high.

Most of you could relate to a product that is highly elastic, because equities represent one product defined by this attribute. A good or service is considered to be highly elastic if a slight change in price leads to a sharp change in the quantity demanded or supplied. For instance, say that Company 123X, a small company with a popular product, decides to go public. During the process of IPO development (Initial Public Offering), the company announces that their initial stock will sell for a few cents more than initially thought. This announcement might create a flurry of sales, an activity that usually drives the price through the ceiling.

In the case above, a limited equity supply is acknowledged, as usually a certain number of shares are offered in an IPO. But, if Company 123X is highly desired, investors are prepared to accept very large risks for the possibility of large gains. Therefore, the demand has risen along with the price, as the investors feel that they will receive more than an expected return on their investment, so they continue to buy as long as possible.

On the other hand, if a company has suffered through several instances of bad press over a short period of time, an investor might not be able to sell her shares as fast as she'd like. The bad press might create a desire in investors to sell, as these individuals no longer desire that company's equities and because investors feel that this equity can be replaced. In this case, the demand has dropped with the price. Both examples show how elastic a good or service might become within minutes.

Have you ever found a rubber band in that box of high school photos in the attic? Did you try to stretch it? I thought so. To enlighten those of you who are too young to discover a rigid rubber band in your attic, if you try to stretch it, it will break. That rubber band has become "inelastic." Goods and services can react the same way, and they don't have to be as old as that rubber band to display this characteristic.

An inelastic good or service is one where changes in price seldom affects the supply or demand for that good or service. One current example of an inelastic good includes gasoline. Although the price has risen tremendously over the past year (over a dollar a gallon), people continue to purchase gas for automobiles that they owned a year ago. This means that they continue to purchase the same amount of gas at a higher price. The demand hasn't curbed, although the price has risen.

When I described gas as "currently" inelastic, I meant exactly that. This inelasticity can change to an elastic nature because some people may exchange their cars for other vehicles that guzzle less gas, because alternatives are available. Additionally, airlines are cutting gas costs (Ever wonder why you're asked to lower the shades when you fly during the daytime these days? That action allows the airlines to run the air conditioners at a higher temperature, thereby saving gas.). And, many people will eventually forgo other options to conserve money rather than to purchase gas, because their money is limited.

Other changes could force the demand for gas to recede, and one option includes the use of vehicles that don't need gas to operate. But, this alternative will take time, as these vehicles are also inelastic. In other words, although the vehicles that don't use gas are available, the supply is limited and the demand for the cars isn't strong yet. Therefore, any change in price - which would be minimal due to lack of supply and demand - currently doesn't affect the supply/demand curve on these cars.

Three situations affect a good's or service's price elasticity:

1. Substitutes: A rubber band cannot be recycled, but it can be replaced by string, paper clips, or even another, newer, rubber band. Anytime a product or service becomes undesirable, that product loses value, especially when it can be replaced.
   
   
2. Money: Since everyone - including the rich - has limits on income, the demand for desirable products or services can take a nosedive when they become too expensive. Unless that rubber band lays golden eggs, people may limit their use of rubber bands if the cost of those rubber bands becomes exorbitant.
   
   
3. Time: Although rubber bands usually aren't on a grocery list, many people desire the use of a rubber band at one time or another to help out around the home or office. But, if rubber bands aren't available and a person continues to forget to purchase rubber bands at the store, over time that person may discover that rubber bands aren't an absolute necessity. Even if the product was given away at the store, that person may feel little desire to take a package home.

When all three situations come into play, an inelastic product may become elastic again or vice versa.

Cora and I are going to be elastic, because we're going to look at some summer reading in the next article before we head into the heady abstracts involved with economic utility.

Until Then,
Linda Goin