Elasticity – UPSC Economics Smart-Prep Module

GS III • Prelims • Microeconomics

1. What is Elasticity?

Elasticity measures the responsiveness of one economic variable to a change in another variable. It tells us how strongly consumers or producers react to price, income, and related goods.

Elasticity is crucial for understanding taxation effects, GST design, pricing decisions, agricultural policy, subsidy targeting, and market efficiency.

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2. Types of Elasticity of Demand

The three primary types of elasticity reflect how quantity demanded reacts to:

• Price changes → Price Elasticity of Demand (PED)
• Income changes → Income Elasticity of Demand (YED)
• Price of related goods → Cross Elasticity of Demand (XED)

A. Price Elasticity of Demand (PED)

PED measures how quantity demanded changes when the price changes. Formula:

Higher elasticity means consumers are more sensitive to price changes. Essential items tend to be inelastic; luxury items tend to be elastic.

B. Income Elasticity of Demand (YED)

Measures response of quantity demanded to a change in consumer income.

C. Cross Elasticity of Demand (XED)

Measures how demand for one good changes when the price of a related good changes.

graph TB
  A[Elasticity of Demand]:::root
  A --> B[Price Elasticity]:::node
  A --> C[Income Elasticity]:::node
  A --> D[Cross Elasticity]:::node

  B --> B1[Response to price]:::note
  C --> C1[Response to income]:::note
  D --> D1[Response to related goods]:::note

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  classDef node fill:#EBF5FB,stroke:#2874A6,color:#1B4F72;
  classDef note fill:#F5F6F7,stroke:#B3B6B7,color:#424949;

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3. Degrees of Elasticity

Elasticity can be classified depending on how strongly quantity responds to price.

graph TB
  A[Degrees of Elasticity]:::root
  A --> B[Perfectly Elastic]:::node
  A --> C[Perfectly Inelastic]:::node
  A --> D[Elastic]:::node
  A --> E[Inelastic]:::node
  A --> F[Unitary]:::node

  B --> B1[Horizontal curve]:::note
  C --> C1[Vertical curve]:::note

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4. Elasticity of Supply (Es)

Elasticity of Supply shows how much quantity supplied changes when the price of a good changes. Producers respond differently based on technology, storage ability, and production period.

Key Insights

• Short run: supply is inelastic due to fixed capacity.
• Long run: supply is elastic as firms can expand production.
• Agriculture has inelastic supply.
• Manufacturing has elastic supply due to scalable production.

graph TB
  A[Elasticity of Supply]:::root
  A --> B[Short Run]:::node
  A --> C[Long Run]:::node

  B --> B1[Low elasticity]:::note
  C --> C1[High elasticity]:::note

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  classDef node fill:#EBF5FB,stroke:#2874A6,color:#1B4F72;
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5. Determinants of Elasticity (Demand & Supply)

A. Determinants of Price Elasticity of Demand (PED)

• Substitutes: more substitutes → higher elasticity.
• Nature of good: necessities inelastic; luxuries elastic.
• Income share: higher expenditure → higher elasticity.
• Time period: elasticity increases over time.
• Brand loyalty: reduces elasticity.

B. Determinants of Elasticity of Supply (Es)

• Time period — the biggest factor.
• Input availability — scarce inputs lower elasticity.
• Flexibility of production.
• Storage ability — more storable goods → elastic supply.

graph TB
  A[Determinants of Elasticity]:::root
  A --> B[Demand Side]:::node
  A --> C[Supply Side]:::node

  B --> B1[Substitutes]:::note
  B --> B2[Income share]:::note

  C --> C1[Time factor]:::note
  C --> C2[Input availability]:::note

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6. Importance of Elasticity in Economics

Elasticity plays a central role in taxation, pricing, subsidies, trade, and welfare analysis.

• Taxation: Inelastic goods = high revenue (petrol, alcohol).
• Pricing: Firms adjust prices depending on elasticity.
• Subsidies: Essential goods with inelastic demand need more support.
• Welfare: Elasticity influences deadweight loss and efficiency.

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7. Elasticity Applications in India – Agriculture, Fuel, GST

A. Agriculture

• Demand & supply are highly inelastic.
• Explains extreme price volatility.
• Relevant for MSP, PDS, buffer stocks.

B. Fuel

• Demand is inelastic.
• Heavily taxed (excise, VAT).

C. GST

• Elastic goods → lower GST slabs.
• Inelastic goods → higher GST slabs.

graph TB
  A[Elasticity in India]:::root
  A --> B[Agriculture]:::node
  A --> C[Fuel]:::node
  A --> D[GST]:::node

  B --> B1[Inelastic supply]:::note
  C --> C1[Inelastic demand]:::note
  D --> D1[Tax slab decisions]:::note

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8. Smart Summary

graph TB
  A[Elasticity Summary]:::root
  A --> B[Demand Elasticities]:::node
  A --> C[Supply Elasticity]:::node

  B --> B1[PED]:::note
  B --> B2[YED]:::note
  B --> B3[XED]:::note

  C --> C1[Es]:::note

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  classDef node fill:#EBF5FB,stroke:#2874A6,color:#1B4F72;
  classDef note fill:#F5F6F7,stroke:#B3B6B7,color:#424949;

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