What is Price Elasticity?

I saw this term used on clarkhoward.com and couldn't remember the exact definition from when I took Econ way back when, so I thought I'd look it up and share it. There are at least two different types of elasticity. Price Elasticity of Demand and Price Elasticity of Supply. They are basically the same thing but for two different variables.

Price Elasticity is simply a measure of how much the Supply or Demand changes with a change in price.

Let's do an example with Price Elasticity of Demand. Say a candy bar is $1 and the demand for it is 100 units and the price is raised to $1.01 and this causes the demand to decrease to 90 units. We can come up with a number that represents how much this difference in price is affecting the demand.

The equation is (P/Q) * (∆Q/∆P) or ∆Q%/∆P%. For our example, let's use the first equation. P = Price = 1.01, Q = Quantity = 90, ∆Q = 90 - 100 = -10, ∆P = 1.01 - 1.00 = .01. Therefore, PED (Price Elasticity of Demand) = 1.01/90 * -10/.01 = -11.22

Note that since the value is negative, it indicates an inverse relationship. Basically, as price increases, the demand decreases. That's usually how it happens, but sometimes you could have weird cases where the fact that it's becoming more expensive makes it more in demand. Perhaps this could happen with an IPO of stock or a rare diamond.

Volcano Causes Financial Strain and Stranded Travelers

MyWay has an associated press article highlighting individuals around the globe that are being affected by the recent volcanic eruption in Europe. Here is another good example of why you need an emergency fund!

Mortgage Payment Inflation

I had an interesting idea this morning when I was reading a Bogleheads post on paying extra on your mortgage. Basically, assuming you are doing a traditional fixed mortgage, your mortgage payments are going to remain pretty much the same throughout the term of your mortgage. However, inflation will take it's toll on the value of your dollar so the real cost of your payment each month will be decreasing. To compensate for that, why not increase your mortgage payment to keep pace with inflation?

For example, if your mortgage payment is $1000 in today's dollars, then 10 years from now you should be paying the equivalent of today's $1000, which at 3% a year is $1,343.92. All of your other expenses will be increasing at that rate, so why not force yourself to pay off your mortgage faster. If your relative level of income has remained the same, you won't notice the difference. Of course, if your situation has changed then the reduced relative cost of the mortgage payment is a great advantage and can help you get by.