magine that some event drives up the price of gasoline in the United
I States. It could be a war in the Middle East that disrupts the world
supply of oil, a booming Chinese economy that boosts the world
demand for oil, or a new tax on gasoline passed by Congress. How
would U.S. consumers respond to the higher price?
It is easy to answer this question in a broad fashion: People would
buy less gas. This conclusion follows from the law of demand we saw
in the previous chapter: Other things being equal, when the price of
a good rises, the quantity demanded falls. But you might want a pre- Elasticity ru1d
cise answer. By how much would gas purchases fall? This question
can be answered using a concept called elasticity, which we examine
in this chapter.
Its Application
Elasticity is a measure of how much buyers and sellers respond
to changes in market conditions. When studying how some event or
polic~ \}ffects a market, we can discuss not only the direction of the
effect.~la.ut also their magnitude. Elasticity is useful in many applica~
tions, as ~e see toward the end of this chapter.
,88 PART II HOW MARKETS WORK
Before p roceeding, how v r, you migh t be u dou about the answ r to the
gasoline questi in. Many stud ies h< ve cx-amined con umers' response to d 1 nges
in gasoli ne p r ices, and they l pically find that th - qulln tity demand d responds
mor ·in the long run th. 11 it d o in :he sh or nlTi . A 10 percent incre. se in gaso-
line p rices redu et; gasolin on umpti on by about 2.5 percent Her a. ear an d b
ab out 6 pe1 ent aft r fiv yeai . Abo ut half of Lhe long-nm red uction in qucntily
d mimded ise because people drive J s , • 1d hal f arises because the switch
to more fuel·dfJcie:nt cars. Both r ponse • re refl ded in th den« nd cu:rvc • nd
its elasticity.
5- The Elasticity of Demand
When we introduced demand in Chapter 4, we noted that consumers usually buy
more of a good when its price is lower, when their incomes are higher, when the
prices of its substitutes are higher, or when the prices of its complements are lower.
Our discussion of demand was qualitative, not quantitative. That is, we discussed
the direction in which quantity demanded moves but not the size of the change. To
measure how much consumers respond to changes in these variables, economists
elasticity use the concept of elasticity.
a measure of the
responsiveness of 5-la The Price Elasticity of Demand and Its Determinants
quantity demanded or The law of demand states that a fall in the price of a good raises the quantity
quantity supplied to demanded. The price elasticity of demand measures how much the quantity
a change in one of its demanded responds to a change in price. Demand for a good is said to be elastic
determinants if the quantity demanded responds substantially to changes in the price. Demand
price elasticity of demand is said to be inelastic if the quantity demanded responds only slightly to changes
a measure of how much in the price.
the quantity demanded The price elasticity of demand for any good measures how willing consumers
of a good responds to a are to buy less of the good as its price rises. Because a demand curve reflects the
change in the price of many onotnk, social, nd psychologic 1 forces tha t ·nape constm1 r preferences,
that good, computed as there is no simple, universal rule for what determines a demand curve's elasticity.
the percentage change Based on experience, however, we can state some rules of thumb about what influ-
in quantity demanded ences the price elasticity of demand.
divided by the percentage
change in price Availability of Close Substitutes A good with close substitutes tends to have
more elastic demand because it is easier for consumers to switch from that good to
others. For example, butter and margarine are easily substitutable. A small increase
in the price of butter, assuming the price of margarine is held fixed, causes the
quantity of butter sold to fall by a large amount. By contrast, because eggs are a
food without a close substitute, the demand for eggs is less elastic than the demand
for butter. A small increase in the price of eggs does not cause a sizable drop in the
quantity of eggs sold.
Necessities versus Luxuries Necessities tend to have inelastic demands, whereas
luxuries have elastic demands. When the price of a doctor's visit rises, people do
not dramatically reduce the number of times they go to the doctor, although they
might go somewhat less often. By contrast, when the price of sailboats rises, the
quantity of sailboats demanded falls substantially. The reason is that most people
, CHAPTER 5 ELASTICITY AND ITS APPLICATION 89
view doctor visits as a necessity and sailboats as a luxury. Whether a good is a
necessity or a luxury depends not on the goad's intrinsic properties but on the
buyer's preferences. For avid sailors with little concern about their health, sailboats
might be a n ecessity with inelastic demand and doctor visits a luxury with elastic
demand.
Definition of the Market The elasticity of demand in any market depends on
how we draw the boundaries of the market. Narrowly defined markets tend to
have more elastic demand than broadly defined markets because it is easier to find
close substitutes for narrowly defined goods. For example, food, a broad category,
has a fairly inelastic demand because there are no good substitutes for food. Ice
cream, a narrow category, has a more elastic demand because it is easy to substitute
other desserts for ice cream. Vanilla ice cream, an even narrower category, has a
very elastic demand because other fla vors of ice cream are almost perfect substi-
tutes for vanilla.
Time Horizon Goods tend to have m ore elastic demand over longer time hori-
zons. When the price of gasoline rises, the quantity of gasoline demanded falls only
slightly in the first few months. Over time, however, people buy more fuel-efficient
cars, switch to public transportation, and move closer to where they work. Within
several years, the quantity of gasoline demanded falls more substantially.
5-lh Computing the Price Elasticity of Demand
Now that we have discussed the price elasticity of demand in general terms, let's
be more precise about how it is measured. Economists compute the price elastic-
ity of demand as the percentage change in the quantity demanded divided by the
percentage change in the price. That is,
. . . fd d Percentage change in quantity demanded
Pnee e1astic1ty o eman = .
Percentage change in price
For example, suppose that a 10 percent increase in the price of an ice-cream cone
causes the amount of ice cream you buy to fall by 20 percent. We calculate your
elasticity of demand as
. 20 percent
Price elasticity of demand = = 2.
10 percent
In this example, the elasticity is 2, reflecting that the change in the quantity
demanded is proportionately twice as large as the change in the price.
Because the quantity demanded of a good is negatively related to its price, the
percentage change in quantity will always have the opposite sign as the percent-
age change in price. In this example, the percentage change in price is a positive
10 percent (reflecting an increase), and the percentage change in quantity demanded
is a negative 20 percent (reflecting a decrease). For this reason, price elasticities of
demand are sometimes reported as negative numbers. In this book, we follow the
common practice of dropping the minus sign and reporting all price elasticities of
demand as positive numbers. (Mathematicians call this the absolute value.) With this
convention, a larger price elasticity implies a greater responsiveness of quantity
demanded to changes in price.
I States. It could be a war in the Middle East that disrupts the world
supply of oil, a booming Chinese economy that boosts the world
demand for oil, or a new tax on gasoline passed by Congress. How
would U.S. consumers respond to the higher price?
It is easy to answer this question in a broad fashion: People would
buy less gas. This conclusion follows from the law of demand we saw
in the previous chapter: Other things being equal, when the price of
a good rises, the quantity demanded falls. But you might want a pre- Elasticity ru1d
cise answer. By how much would gas purchases fall? This question
can be answered using a concept called elasticity, which we examine
in this chapter.
Its Application
Elasticity is a measure of how much buyers and sellers respond
to changes in market conditions. When studying how some event or
polic~ \}ffects a market, we can discuss not only the direction of the
effect.~la.ut also their magnitude. Elasticity is useful in many applica~
tions, as ~e see toward the end of this chapter.
,88 PART II HOW MARKETS WORK
Before p roceeding, how v r, you migh t be u dou about the answ r to the
gasoline questi in. Many stud ies h< ve cx-amined con umers' response to d 1 nges
in gasoli ne p r ices, and they l pically find that th - qulln tity demand d responds
mor ·in the long run th. 11 it d o in :he sh or nlTi . A 10 percent incre. se in gaso-
line p rices redu et; gasolin on umpti on by about 2.5 percent Her a. ear an d b
ab out 6 pe1 ent aft r fiv yeai . Abo ut half of Lhe long-nm red uction in qucntily
d mimded ise because people drive J s , • 1d hal f arises because the switch
to more fuel·dfJcie:nt cars. Both r ponse • re refl ded in th den« nd cu:rvc • nd
its elasticity.
5- The Elasticity of Demand
When we introduced demand in Chapter 4, we noted that consumers usually buy
more of a good when its price is lower, when their incomes are higher, when the
prices of its substitutes are higher, or when the prices of its complements are lower.
Our discussion of demand was qualitative, not quantitative. That is, we discussed
the direction in which quantity demanded moves but not the size of the change. To
measure how much consumers respond to changes in these variables, economists
elasticity use the concept of elasticity.
a measure of the
responsiveness of 5-la The Price Elasticity of Demand and Its Determinants
quantity demanded or The law of demand states that a fall in the price of a good raises the quantity
quantity supplied to demanded. The price elasticity of demand measures how much the quantity
a change in one of its demanded responds to a change in price. Demand for a good is said to be elastic
determinants if the quantity demanded responds substantially to changes in the price. Demand
price elasticity of demand is said to be inelastic if the quantity demanded responds only slightly to changes
a measure of how much in the price.
the quantity demanded The price elasticity of demand for any good measures how willing consumers
of a good responds to a are to buy less of the good as its price rises. Because a demand curve reflects the
change in the price of many onotnk, social, nd psychologic 1 forces tha t ·nape constm1 r preferences,
that good, computed as there is no simple, universal rule for what determines a demand curve's elasticity.
the percentage change Based on experience, however, we can state some rules of thumb about what influ-
in quantity demanded ences the price elasticity of demand.
divided by the percentage
change in price Availability of Close Substitutes A good with close substitutes tends to have
more elastic demand because it is easier for consumers to switch from that good to
others. For example, butter and margarine are easily substitutable. A small increase
in the price of butter, assuming the price of margarine is held fixed, causes the
quantity of butter sold to fall by a large amount. By contrast, because eggs are a
food without a close substitute, the demand for eggs is less elastic than the demand
for butter. A small increase in the price of eggs does not cause a sizable drop in the
quantity of eggs sold.
Necessities versus Luxuries Necessities tend to have inelastic demands, whereas
luxuries have elastic demands. When the price of a doctor's visit rises, people do
not dramatically reduce the number of times they go to the doctor, although they
might go somewhat less often. By contrast, when the price of sailboats rises, the
quantity of sailboats demanded falls substantially. The reason is that most people
, CHAPTER 5 ELASTICITY AND ITS APPLICATION 89
view doctor visits as a necessity and sailboats as a luxury. Whether a good is a
necessity or a luxury depends not on the goad's intrinsic properties but on the
buyer's preferences. For avid sailors with little concern about their health, sailboats
might be a n ecessity with inelastic demand and doctor visits a luxury with elastic
demand.
Definition of the Market The elasticity of demand in any market depends on
how we draw the boundaries of the market. Narrowly defined markets tend to
have more elastic demand than broadly defined markets because it is easier to find
close substitutes for narrowly defined goods. For example, food, a broad category,
has a fairly inelastic demand because there are no good substitutes for food. Ice
cream, a narrow category, has a more elastic demand because it is easy to substitute
other desserts for ice cream. Vanilla ice cream, an even narrower category, has a
very elastic demand because other fla vors of ice cream are almost perfect substi-
tutes for vanilla.
Time Horizon Goods tend to have m ore elastic demand over longer time hori-
zons. When the price of gasoline rises, the quantity of gasoline demanded falls only
slightly in the first few months. Over time, however, people buy more fuel-efficient
cars, switch to public transportation, and move closer to where they work. Within
several years, the quantity of gasoline demanded falls more substantially.
5-lh Computing the Price Elasticity of Demand
Now that we have discussed the price elasticity of demand in general terms, let's
be more precise about how it is measured. Economists compute the price elastic-
ity of demand as the percentage change in the quantity demanded divided by the
percentage change in the price. That is,
. . . fd d Percentage change in quantity demanded
Pnee e1astic1ty o eman = .
Percentage change in price
For example, suppose that a 10 percent increase in the price of an ice-cream cone
causes the amount of ice cream you buy to fall by 20 percent. We calculate your
elasticity of demand as
. 20 percent
Price elasticity of demand = = 2.
10 percent
In this example, the elasticity is 2, reflecting that the change in the quantity
demanded is proportionately twice as large as the change in the price.
Because the quantity demanded of a good is negatively related to its price, the
percentage change in quantity will always have the opposite sign as the percent-
age change in price. In this example, the percentage change in price is a positive
10 percent (reflecting an increase), and the percentage change in quantity demanded
is a negative 20 percent (reflecting a decrease). For this reason, price elasticities of
demand are sometimes reported as negative numbers. In this book, we follow the
common practice of dropping the minus sign and reporting all price elasticities of
demand as positive numbers. (Mathematicians call this the absolute value.) With this
convention, a larger price elasticity implies a greater responsiveness of quantity
demanded to changes in price.
