Elasticity of Demand
Demand for a good is said to be “elastic” if a small change in price causes people to demand a lot more or a lot less of the good. Demand for a good is “inelastic” if a small change in prices causes people to make no change or almost no change in how much they demand of that good.
If the price of gasoline at the pump rises, the amount of gas people demand falls. But, does it fall by a lot or only by a little? The price elasticity of demand is all about answering that question. If a 10% increase in the price of gas results in almost no change in the amount of gas people want to buy, we say the price elasticity of demand for gas is inelastic. If it results in a very large reduction in the amount of gas they want to buy, we say the price elasticity of demand for gas is elastic.
Usually economists describe demand as either relatively elastic or relatively inelastic when compared to an imaginary neutral amount of elasticity. That is, if a 10% increase in price results in a 10% decrease in the amount of the good demanded, we think of that as a neutral elasticity of demand. If we know demand for gas is relatively inelastic, we can estimate that when the price of gas goes up by 10% people will not change their buying habits very much, buying almost the same amount of gas as before–that is, reducing their gas purchases by less than 10%. If we know demand for gas is relatively elastic, we can estimate that a 10% increase in the price of gas will cause the quantity of gas demanded at the pump to fall by over 10%.
The price elasticity of demand often depends on how long a time period is involved. The day after the price of gas falls, people may not change their gas purchases or driving habits very much. Perhaps their tanks are already full enough to get where they have already planned to go. But within a week or a month, people will notice that the fall in the price of gas now enables them to travel a little more than they’d previously planned, or relax their daily driving habits and not worry so much about driving to get groceries weekly instead of every other week. That is, after a week or a month, the price elasticity of demand may increase and eventually may settle in at a new level. It is also possible for people to overreact to a price change. For example, perhaps people fear that the price will rise again soon and they will lose out on an opportunity. That is, the price elasticity of demand probably changes over time, before settling down. It often takes more time for people to adjust to a sudden, unexpected price change than to a price change they expected because they have more time to rethink their plans when price changes are predicted or announced in advance.
Definitions and Basics
Elasticity, from Investopedia.com
Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in relation to its price change….
Elasticity and Its Expansion, by Morgan Rose in Teacher’s Corner at Econlib
As this semester closed, I asked several colleagues who taught introductory economics courses to name the most difficult topics to teach to first-time economics students. There was some variation in their answers, but one concept was mentioned far more often than any other—elasticity. In this Teacher’s Corner, we will define what elasticity means in economics, explain how one particular type of elasticity is calculated, and discuss why the concept is critical to economic agents trying to maximize their revenue….
In the News and Examples
McKenzie on Prices. Podcast. EconTalk, June 23, 2008. Elastic and inelastic demand at time mark 33:52.
Richard McKenzie of the University California, Irvine and the author of Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles,talks with EconTalk host Russ Roberts about a wide range of pricing puzzles. They discuss why Southern California experiences frequent water crises, why price falls after Christmas, why popcorn seems so expensive at the movies, and the economics of price discrimination.
A Little History: Primary Sources and References
Alfred Marshall, biography from the Concise Encyclopedia of Economics
To Marshall also goes credit for the concept of price-elasticity of demand, which quantifies buyers’ sensitivity to price….
The Elasticity of Wants, by Alfred Marshall. Book III, Chapter 4 from Principles of Economics
The elasticity of demand is great for high prices, and great, or at least considerable, for medium prices; but it declines as the price falls; and gradually fades away if the fall goes so far that satiety level is reached…. [par. III.IV.4]
Water is one of the few things the consumption of which we are able to observe at all prices, from the very highest down to nothing at all. At moderate prices the demand for it is very elastic. But the uses to which it can be put are capable of being completely filled: and as its price sinks towards zero the demand for it loses its elasticity. Nearly the same may be said of salt. Its price in England is so low that the demand for it as an article of food is very inelastic: but in India the price is comparatively high and the demand is comparatively elastic…. [par. III.IV.12]