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What is the theory of elasticity and what does this mean for my day-to-day life? The Theory of Elasticity was coined by Professor S. Singh in 1957 as a way to measure different economic changes. It is now applied to all sorts of industries, such as airlines and supermarkets, as a way to see how changing prices will impact their market. But what does the theory of elasticity have to do with us? One thing that we can't really change about our lives is inflation — we will always be faced with higher prices for goods and services. How can we then still think about inflation as a good thing? Professor Singh set out to try and find out how consumers would react to various levels of inflation. It was important that he could test this theory with very little data, because the variables that he could test might not be statistically significant. He tested his theory first on three variables: food prices, petrol prices, and housing costs. The first question about the theory of elasticity is: what is it? To answer this question specifically for food prices, Professor Singh needed to take the price of one item (the "i", or "input") and multiply by a number called "k". One output (the "o", or "output") is then obtained by multiplying the unit price (the "p") by the amount of the item used (the "q"). The theory can be summarized as: log(1 + k) = log(1 + p) - log(1 + q). In other words, if we take a good such as food and buy it in increasing amounts, the increase in cost will be greater than if we buy less. He tested this theory on five variables: 1, 2, 3, 5 and 10 percent inflation. All press releases were made at a release rate of 1 percent for all variables. To have a smooth release of the values, Professor Singh decided to look at how the variables changed at different rates. For each variable, he looked at how it changed if the release was constant or if it was accelerated to 50 percent. Then he adjusted his calculations so that they would be comparable regardless of rate of inflation. If "r" is the inflation rate, then there are four scenarios for k: The chart above shows that as inflation rises, consumers will buy less. If stable releases are used, then this is not seen in all cases. The implication is that if people want high inflation to continue for a long period of time, they can manipulate prices by manipulating the rate of inflation. This can make people feel as though they are experiencing more inflation than is occurring. Inflation is important because it affects people's financial situation. In a 2013 article, "How to deal with rising prices", Harvard economist Greg Mankiw wrote that "Inflation has a negative effect on the economy because it raises the real value of a dollars worth of goods and services." In a 2011 article "Measuring Inflation", the Bank of England also referenced this idea: "Inflation is, therefore, thought to have a number of undesirable effects on both individuals and macroeconomic objectives. For example, it erodes the real value of savings income, raises investment costs and reduces investment in new capital equipment. cfa1e77820
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