A brief discussion on Elasticity of supply and demand, focusing on healthcare

1. Elasticity of Demand and Supply
Brigadier General Dr Zulfiquer Ahmed Amin
M Phil, MPH, PGD (Health Economics), MBBS, Fellow (AIIMS, Delhi)

2. What is Elasticity
Elasticity is a measure of a variable's sensitivity to a change in other variables. Price elasticity
refers to the degree to which consumers, or producers change their demand or the amount
supplied in response to changes in price.
When the value of elasticity>1.0, it suggests that the demand for the good or service is more
than proportionally affected by the change in its price (Example: Luxury goods, airline
tickets). A value is <1.0 suggests that the demand is insensitive to price, or inelastic. Inelastic
means that consumers’ buying habits remain almost unchanged when the price either goes
up, or down (Example: Necessities like food and fuel).

3. Price Elasticity of Demand
The extent to which the demand for a product is affected by its price is known as "price
elasticity of demand."

4. Types of Elasticity of Demand
• Perfectly elastic
• Elastic
• Perfectly inelastic
• Inelastic, and
• Unitary

5. A good is perfectly elastic if the price elasticity is infinite (if demand changes substantially
even with minimal price change). In perfectly elastic demand, a small rise in price results in
fall in demand to zero, while a small fall in price causes increase in demand to infinity. The
reason being as the denominator of a fraction approaches zero, the value of the fraction
approaches infinity. In such a case, the demand is perfectly elastic or ep = ∞.
In terms of formula, a 5% increase in demand with very tiniest reduction in price will give us
the equation :
EP = 5 / 0 = infinity elasticity of demand
This type of demand isn't common since several factors influence consumers' buying
decisions other than the price. A consumer could consider their loyalty to the brand, the
distance they need to travel to buy the product, the delivery time to get the product and the
overall quality.

6. When consumers are extremely sensitive to changes in price, they have perfectly elastic
demand as “all or nothing.” Perfect elastic demand means that quantity demanded will
increase to infinity when the price decreases slightly, and quantity demanded will decrease to
zero when price increases tiniest. A perfectly elastic demand curve is horizontal, meaning
quantity demanded can change by any amount without changing price. For example, luxury
cars. These types of products can be easily substituted and if their prices rise slightly, the
demand will drop.
In perfectly elastic demand, the demand curve is represented as a horizontal straight line

7. Relatively Elastic Demand
When the percentage change in demand is more than the percentage change in price, the
demand is relatively elastic. Goods like designer brands, TVs, designer clothing, jewelry are
good examples of relatively elastic demand. For example, if the price of a product increases
by 10.5% and the demand of the product decreases by 28.6% (In figure below), then the
demand would be relatively elastic.

8. Perfectly Inelastic Demand
A perfectly inelastic demand is one when there is no change in quantity demand for a
product with change in its price. The numerical value for perfectly inelastic demand is zero
(ep=0).

9. Movement in price from P1 to P2 and P2 to P3 does not show any change in the demand of
a product (OQ). The demand remains constant for any value of price. In case of essential
goods, such as salt, the demand does not change with change in price. Therefore, the
demand for essential goods is perfectly inelastic.
In case of perfectly inelastic demand, demand curve is represented as a straight vertical line
Price Change > No change in Quantity Demand

13. Relative Inelastic Demand
More change in the price of the goods but less change in demand for the goods. In graph,
price of the goods increased 40% and eventually the demand for the goods decreases 10%.
The proportionate change in price is more than the proportionate change in demand.
Examples of goods with inelastic demand include gasoline, necessary foods, and
prescription drugs.

14. Unitary Elastic Demand
When proportionate or percentage change in quantity demanded is exactly equal to
proportionate or percentage change in price, then demand is said to be unitary elastic. For
instance a 10% fall in price of a commodity leads to 10% rise in demand of that commodity.
Examples of unit elastic products are household appliances, basic electronics and normal
clothing.

16. Factors that Affect the
Elasticity of Demand
The three factors that influence the price elasticity of demand are:
•Substitutes – the more substitutes available for products will make the demand more elastic.
•Necessity – If the product is a basic need, people will be willing to pay a higher price for the
product. For example, gas, even if gas doubles, you will still have to fill up your tank to get to
the office daily.
•Time – If the price of cigarettes goes up by $1 per pack, and there aren’t a lot of substitutes,
the smoker will keep buying his cigarettes, showing an inelastic demand. The price does not
influence the quantity of demand. However, if the smoker cannot afford the $1 per pack more
that he needs to pay and decides to stop smoking over time, then the price elasticity of
cigarettes will become elastic over the long run.
•Brand Loyalty
•Income

17. Importance of price elasticity of demand
Knowing the price elasticity of demand for goods allows someone selling that good to make
informed decisions about:
-Pricing strategies
-To determine consumer pricing sensitivity.
-Determine manufacturing plans
-For governments to assess how to impose taxes on goods.
-Determination of Output Level
-Demand Forecasting
-For govt to adopt policy of protection (eg, Subsidy)
-To gain from International Trade:
A country will gain from international trade if it exports goods with less elasticity of demand
and import those goods for which its demand is elastic.

18. Cross Elasticity of Demand
Cross elasticity of demand evaluates the relationship between two products when the price in
one of them changes. Cross Elasticity of demand refers to the way that changes in the price of
one good can affect the quantity demanded of another good. This relationship can vary
depending on whether the two goods are substitutes, complements, or unrelated to each
other.
Cross price elasticity of demand (XED) = (∆QX/QX) ÷ (∆PY/PY)
Where,
QX = Quantity of product X
PY = Price of the product Y
∆ = Change in the quantity demanded/price

19. Positive Cross Elasticity of Demand (Ec>0):
When increase in price in one commodity (Say Y), leads to an increase in the demand of
another good (Say X) is positive cross elasticity of demand. This means two products are
substitute to each other. Example tea and coffee.
(XED) = (∆QX/QX) ÷ (∆PY/PY)

20. Negative Cross Elasticity of Demand (Ec<1):
When fall in price of one commodity (Y), leads to an increase in the demand of another
related commodity (X), other things remaining same, are complementary to each other.
Example pen and ink.
Zero Cross Elasticity (Ec=0)
When change in price of one commodity (Y), does not affect the demand for another
commodity (X), then two goods are not related to each other. Example tea and laptop.

21. Income Elasticity of demand
Income elasticity of demand (YED) measures how demand for something changes when
income rises or falls.

22. Price Elasticity of Supply (Es)
The ‘price elasticity of supply' is a measure of the degree of responsiveness of the quantity
supplied to the change in the price of a given commodity.
Overview
• When there is a change in price and firms respond with a slight change in the quantity
supplied, then the supply for that good is quite inelastic (Es<1).
• When there is a change in price, which leads to a more significant change in quantity
supplied, the supply for that good is quite elastic (Es>1).
• An elasticity of zero (Es=0) indicates that quantity supplied does not respond to a price
change: the good is "fixed" in supply.

23. Factors Influence Supply Elasticity
They include:
•Price: Producers tend to cut prices when supplies are abundant.
•Availability of Resources (Inputs rare): When the demand for a product rises, it may be
impossible for a firm to meet that demand if the manufacture of their product depends on a
resource that is becoming rare.
•Technology and Innovation: More efficient production reduces costs and allows for larger
production numbers at lower prices.
•Competition: An increase in the number of suppliers makes the price of a product or service
more elastic.
•Time period. Supply tends to be more inelastic in the short term. In contrast, over more
extended periods, firms have the opportunity to construct new factories or shut down older
ones, hire more labor, invest in more capital, etc. Therefore, the supply, in the long run, is
more elastic.

25. Demand and Supply Elasticity in Healthcare
The range of price elasticity estimates for healthcare is relatively wide, it tends to center on
0.17, meaning that a 1 percent increase in the price of health care will lead to a 0.17 percent
reduction in health care expenditures (Elasticity<1). Thus Health Care market has inelastic
demand. The patient will pay what she can or what she must. That means the demand for
health care does not change according to changes in prices of services. The prices may fall or
rise, but the demand remains same.

26. Income elasticity of
healthcare demand
The income elasticity of health expenditure can be defined as the percentage change in
health expenditures in response to a given percentage change in income. The estimates of
income elasticity of demand are in the range of 0 to 0.2. Income elasticity below 1 denotes
healthcare expenditure as an income inelastic and therefore a “necessary” good.
Income elasticity of demand describes the sensitivity to changes in consumer income relative
to the amount of a good that consumers demand. Highly elastic goods will see their quantity
demanded change rapidly with income changes, while inelastic goods will see the same
quantity demanded even as income changes. As demand for healthcare is inelastic to income;
so the demand will remain the same as before rise of income.

27. Preventive care and pharmacy benefits are among those medical services with larger price
elasticities. The number of available substitutes for a product is a major determinant of
demand elasticity. As a result, when the price of care increases, consumers are able to
substitute away from preventive care toward other goods and services that promote health
such as nutritional supplements and healthy foods.