The elasticity of demand

Elasticity: A measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants.

Consumers usually buy more of a good when its price is lower, when their incomes are higher when the prices of substitutes for the good are higher or when the prices of complements of the god 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 use the concept of elasticity.

The Price Elasticity of Demand and its Determinants

A measure of how much the quantity demanded of good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price.

The law of demand states that a fall in the price of a good raises the quantity demanded. The price elasticity of demand measured how much the quantity demanded responds to a change in price. Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price. Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price.

The price elasticity of demand for any good measures how willing consumers are to move away from the good as its price rises. Thus, the elasticity reflects the many economic, social and psychological forces that shape consumer tastes. Based on experience however, we can state some general rules about what determines the price elasticity of demand.

Availability of close substitutes

Goods with close substitutes tend 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.

Necessities versus Luxuries

Necessities tend to have inelastic demands whereas luxuries have elastic demands. When the price of a visit to the doctor rises, people will not dramatically alter the number of times they go to the doctor although they might go some what less often. By contrast when the price of sailboats rises, the quantity of sailboats demanded falls substantially. The reason is that most people view doctor visits as a necessarily as a luxury. Of course, whether a good is a necessity or a luxury depends not on the intrinsic properties of the good but on the preferences of the buyer. For avid sailors with little concern over their health, sailboats might be a necessity with inelastic demand and doctor visits a luxury boat 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 narrower category has a more elastic demand because it is easy to substitute other desserts for ice cream. Vanilla ice cream a very narrow category has a very elastic demand because other favors of ice cream are almost perfect substitutes for vanilla.

Time Horizon

Goods tend to have more elastic demand over longer time horizons. 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 substantially.