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Why Some Prices Move More than Others

Elasticity is another important microeconomic factor.

Elasticity is not the measure of how stretchy those elastic bands that you aimed at your siblings were. It is the measure of price sensitivity.

Huh? How could prices have feelings? Well, that’s not exactly what we mean.

We just learned that as demand increases, price increases – but, how do you measure that increase?

Price sensitivity has to do with how much the demand for a product changes as its price changes. Products that are necessities are more insensitive to changes in price because, well, we need them. For example, if the price of water goes up, our demand won’t go down that much because we need it to live. Conversely, if the price of golf clubs goes up, demand is more likely to go down because you don’t need them as much (unless of course you’re Tiger Woods).

So elasticity is the measure of price sensitivity (or insensitivity). A product that has large swings in demand depending on its price (such as the golf clubs) is elastic, whereas a product that sees less of a shift in demand (like water) is considered inelastic. 

Elastic demand
Inelastic Demand

Images courtesy http://economicseducationhs.blogspot.ca

So why does all this matter?

Excellent question. It’s important to note that as an economy strengthens, and people are making more money, products become more inelastic because people are willing to spend more. The opposite goes for a tightening economy. When people are making less money, more products become elastic and only the essentials remain inelastic.

This has major implications on the stock market. A company like Proctor & Gamble, that sells necessities like toilet paper and shampoo, will be hit less by a recession than a company like Apple, that sells electronics. So companies that sell inelastic goods would be a safer stock pick for risk averse investors.

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