Overview

If the price of Pizza doubles, you buy less Pizza. If the price of Insulin doubles, you buy the same amount of Insulin (because you need it to live). That difference is Elasticity. It measures how sensitive you are to price changes.

Core Idea

The core idea is Responsiveness.

  • Elastic: Rubber band. Stretches a lot. (Luxury goods).
  • Inelastic: Rock. Doesn’t stretch. (Necessities).

Formal Definition

The percentage change in quantity demanded divided by the percentage change in price. Formula: $E_d = \frac{% \Delta Q}{% \Delta P}$

Intuition

  • Elastic Demand (>1): Price goes up 10%, Sales drop 20%. (Bad for business to raise prices).
  • Inelastic Demand (<1): Price goes up 10%, Sales drop 1%. (Good for business to raise prices).

Examples

  • Gasoline: Inelastic in the short term. You still need to drive to work. But Elastic in the long term (you buy an electric car).
  • Salt: Perfectly Inelastic. It’s so cheap that even if the price doubles, you won’t change how much you put on your fries.
  • Airline Tickets: Highly Elastic. If Delta is $10 more than United, you switch.

Common Misconceptions

  • Slope = Elasticity: No. A straight line demand curve has different elasticity at different points.
  • Cross-Price Elasticity: How the price of Hot Dogs affects the demand for Buns (Complements) or Burgers (Substitutes).
  • Income Elasticity: If you get rich, do you buy more of it? (Normal Good) or less of it? (Inferior Good, like Ramen noodles).

Applications

  • Taxation: The government likes to tax Inelastic goods (Cigarettes, Alcohol) because people will keep buying them, so the tax revenue is stable. (Sin Tax).

Criticism / Limitations

  • Hard to measure: You can’t just ask people “What would you do if price doubled?” They lie. You have to look at real sales data.

Further Reading

  • Mankiw, N. Gregory. Principles of Economics.