[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

in question. If the price of orange juice rises, consumers have an incentive to buy
less orange juice and to buy apple juice, cranberry juice, or any one of a number of
other drinks instead. If a new tax pushes up the price of gasoline, drivers likewise have
an incentive to reduce their consumption of gas; but doing so may be difficult for
those who have to drive to work in cars with conventional engines. Some may be
able to ride the bus, but many will be hard-pressed to find an alternative means of
transportation. And switching to an electric or hybrid vehicle can be costly.
As these examples illustrate, substitutes exist for almost every good or service,
but substitution will be more difficult for some goods and services than for others.
When substitution is difficult, an increase in the price of a good will not cause
the quantity demanded to decrease by much, and a decrease in the price will
not cause the quantity demanded to increase much. In terms of the demand curves
we discussed in Chapter 3, the demand curve for a good with few substitutes
will be relatively steep: changes in price do not cause very large changes in the
quantity demanded.
When substitution is easy, as in the case of orange juice, an increase in price may
lead to a large decrease in the quantity demanded. Ice cream is another example of
a good with many close substitutes. A price increase for ice cream means that frozen
yogurt, gelato, and similar products become relatively less expensive, and the demand
for ice cream would thus significantly decrease. The demand curve for a good with
many substitutes will be relatively flat: changes in price cause large changes in the
quantity demanded.
For many purposes, economists need to be precise about how steep or how flat
the demand curve is. They therefore use the concept of the price elasticity of
demand (for short, the price elasticity or the elasticity of demand), which is defined
as the percentage change in the quantity demanded divided by the percentage change
in price. In mathematical terms,
percentage change in quantity demanded
elasticity of demand = .
percentage change in price
If the quantity demanded changes 8 percent in response to a 2 percent change in
price, then the elasticity of demand is 4.
(Price elasticities of demand are really negative numbers; that is, when the price
increases, quantities demanded are reduced. But the convention is to simply give
the elasticity’s absolute value with the understanding that it is negative.)
It is easiest to calculate the elasticity of demand when there is just a 1 percent
change in price. Then the elasticity of demand is just the percentage change in the
quantity demanded. In the telescoped portion of Figure 4.1A, we see that increasing
the price of orange juice from $2.00 a gallon to $2.02—a 1 percent increase in
price—reduces the demand from 100 million gallons to 98 million, a 2 percent decline.
So the price elasticity of demand for ice cream is 2.
By contrast, assume that the price of gas increases from $2.00 a gallon to $2.02
(again a 1 percent increase in price), as shown in the telescoped portion of Figure
4.1B. This reduces demand from 100 million gallons per year to 99.8 million. Demand
has gone down by 0.2 percent, so the price elasticity of demand is therefore 0.2.
Larger values for price elasticity indicate that demand is more sensitive to changes
in price. Smaller values indicate that demand is less sensitive to price changes.
78 ∂ CHAPTER 4 USING DEMAND AND SUPPLY