Mankiw's Textbook on Determinants of Demand Elasticity
By David Henderson
In the Energy Economics course I’m teaching this quarter, I have a number of students who have never had economics before. So I’m using selected chapters from the Microeconomics portion of Greg Mankiw’s Principles of Economics, and I add a few dozen readings from the literature, especially from the literature on energy. I use the 5th edition of Mankiw so that the students spend closer to $20 than to $150.
I like the book, which is why I use it, but each time I use it, I find things that are off. This is about one of those.
In a section on determinants of elasticity of demand, Mankiw lists four. The first is “Availability of Close Substitutes.” The third is “Definition of the Market.”
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 [by the way, this is not my criticism, but some students will read that as “assuming the government keeps the price fixed,” when what he really means is “assuming the price of margarine doesn’t change”] causes the quantity of butter sold so 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.”
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 easier to substitute other desserts for ice cream. Vanilla ice cream, a very narrow category, has a very elastic demand because other flavors of ice cream are almost perfect substitutes for vanilla.
On their own, each of these is fine. The problem is that Mankiw never makes it clear that they are the same point. Notice how he discusses the definition of the market. It’s all about close substitutes, which is the point of his “Availability of Close Substitutes” point.