Elasticity: The real stretch play.
We have all heard the phrase, “Stretch your dollar”, but have you ever stopped to consider what all goes on behind the scenes in order to make this stretch occur? What rules of economics and finance play into making your hard-earned dollar stretch to its maximum value? While the topic of stretching your money spans across all areas of business, finance, and economics, I will focus on the fundamental principle of economic stretch; elasticity. Elasticity in economics is very similar to elasticity in every other discipline. It’s all about the stretch. How much pressure can that elastic waistband take before it breaks? How much give is in that rubber band? How much will increasing the price of that product affect its demand? All similar questions related to elasticity. A few terms I need to define as they relate specifically to economics include; the elasticity of demand, cross-point elasticity, and income elasticity. The elasticity of demand refers to the degree to which demand for a particular good or service varies with price of that good or service. Think lower prices higher volume, lower volume, higher prices. Take for instance the all-powerful smartphone. If a smart-phone producing company has the latest and greatest smartphone and releases fewer phones than are demanded, the phones price could go up drastically, if, however, the smartphone producing company releases too many smartphones then the price of the phones could drop due to the station of the market. Finding the perfect balance of volume and price is what will help keep that dollar stretching. The next term is cross-point elasticity. Cross-point elasticity is the proportionate change in the demand for a particular good or service in response to a change in price of another good or service. There are two main parties of cross-point elasticity, the positive party with substitute goods and services, and the negative party with complement goods and services. In the positive party, as the price for one good or service increases the demand for a substitute good or service increases. (This is the basis of competition in the market, but I’ll save that for another assignment!) So in a positive party say the price of product A, say butter increases. This would increase the demand of product B, say margarine. In the previous example margarine would be the substitute good for butter. In a negative party on the other hand, as the price of one good or service increases, the demand for a complement good or service decreases. So, referring again to my previous example, the price of product A, again with the butter, increases. This decreases the demand for product C, say bread. If you can’t afford to buy your favorite butter, why would you have any need for the bread? The last term I would like to explain is income elasticity. Income elasticity measures the relationship between the change in consumer income and the change in the sale of particular goods and services. This basically means that as consumer income increases or decreases the demand for various goods or services will also increase or decrease. The change in demand will categorize those goods and services as either luxury, normal or inferior goods. The elasticity of each of these types of goods and services varies. Luxury goods are income elastic, normal goods are classified as income inelastic, and inferior goods and services are classified as being negative income inelastic. Now for an example: Product X, rentals of stretch party limos. I decrease in someone’s income has a drastic effect on the demand of X. You have to have the big dollars to ride to the club in style! Product Y, the standard yellow cab, could be considered a normal good or service. The increase or decrease in income increases and decreases the demand for product Y, but the demand is much less sensitive than a luxury good. As we make more or less money, we want to go out more or...
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