The Economics Book

124

IF YOU GET A

PAY RAISE, BUY

CAVIAR NOT BREAD

ELASTICITY OF DEMAND

T

he “elasticity” of demand

is its responsiveness to

changes in another factor,

such as price. British economist

Alfred Marshall (p.110) is generally

credited as the first economist to

define the concept in 1890, but the

German statistician Ernst Engel

published a paper five years earlier,

showing how changes in income

alter the level of demand. The

origins of the concept may be

disputed, but its importance is

not. Elasticity of demand quickly

became one of the most widely

used tools of economic analysis.

Marshall had been one of the

first to formalize the idea that

demand fell as prices rose. It took

only a small step from this to see

how the demand for different

products (such as bread and caviar)

varied by differing amounts when

the price of those products changed.

Marshall saw that when prices

changed for necessities such as

bread, demand changed very little.

Bread is very unresponsive to

changes in price because it has

few substitutes. On the other hand

demand for luxuries might be much

more responsive to price—such a

product is said to be “price-elastic.”

Marshall recognized that among

people on average incomes, demand

for a luxury such as caviar is much

more sensitive to price change than

it is among the super-rich, who can

afford as much as they like.

Engel’s law

Ernst Engel argued that as people

grow richer, they increase spending

on food by less than their increase

in income. Demand for food is

“income-inelastic”—an idea that

became known as Engel’s law.

IN CONTEXT

FOCUS

Decision making

KEY THINKER

Ernst Engel (1821–96)

BEFORE

1817 British political

economist David Ricardo

criticizes the charging of rent

on land because its supply is

unable to respond to price.

1871 Austrian economist Carl

Menger claims falling marginal

utility (the worth of each extra

unit) influences demand.

AFTER

1934 British economist

John Hicks uses the concept

of elasticity to measure how

easily products can be

substituted for each other.

1950 Argentine economist

Raúl Prebisch and German-

born British economist Hans

Singer independently show

how the benefits of trade will

favor richer countries that

produce manufactured goods.

Designer clothes are luxury goods

that take up a greater proportion of

income as a person’s income rises.

Necessities such as bread will take

a declining proportion of income.