If I push against a rock, it will not change shape. The same is not true of a rubber band, or a piece of plastic. In physics, the technical definition of "elasticity" is the extent to which something changes when a force is applied. As such, rocks, most metals, and wood are all inelastic; dough, rubber, or fabric are all relatively elastic. When economists needed a term to explain how much one variable changed in response to another variable, they borrowed this metaphor from physics.

Note that there are a variety of different elasticities, and we will cover several in this chapter. We begin, however, with the most common usage: how much quantity demanded responds when price changes.

To link back to our physics analogy, there are some goods that are like rocks: if price changes, people do not shift in their consumption. Inelastic goods include things like gasoline (people have to get to work), basic foodstuffs (people have to eat), and emergency medical care (gotta live to be able to... live). Elastic goods are those whose quantity demanded shifts substantially with a relatively small change in price: going out to eat, theater tickets, and airplane travel. As a general rule, elastic goods include luxury items, items that have close substitutes, and items that you have time to find substitutes for. Inelastic goods are necessities, items with few substitutes, and items that come with a deadline that you can't get out of.

Let's get to a technical definition: Price elasticity of demand (often simply PED) measures how strongly quantity demanded responds when price changes. The standard formula is:

Ed= (% change in quantity demanded) / (% change in price)

Now, a quick note about how economists talk about elasticity. Demand curves slope downward, which means that the raw calculation of elasticity is most often negative. As a shorthand, most economists simply talk about the absolute value. So if price rises 10 percent and quantity demanded falls 20 percent, demand elasticity is technically -2, but economists will simply say "2." Buyers are responsive; they have escape power. If price rises by 10 percent and quantity demanded falls by only 2%, the elasticity would be -0.2, buyers are mostly locked in to purchasing no matter the cost. Economists would simply call this an elasticity of 0.2.

It can be helpful to think of extreme cases to help build an intuition around elasticities. An infinitely elastic good is one in which an infinitesimal shift in price (i.e. one cent) results in 100% shift in consumption to something else. An infinitely inelastic good is one in which an infinite shift in price results in a 0% shift in consumption.

Note that elasticity is not about whether people like something. It is about how easily they can change when the price changes. A person may love a restaurant but switch when prices rise. A person may hate paying for medicine but still buy it because the alternative is dangerous.

What determines elasticity?

Economist Alex Tabarrok is famous for using the "e" in "elasticity" to stand for "escape." It's a good rule of thumb: elasticity comes from the conditions around a choice. If substitutes are easy to find, demand is more elastic. If a good is a necessity, demand is more inelastic. If buyers have time to adjust, elasticity usually rises. If the good takes a large share of the budget, people search harder for alternatives.

Addiction and dependency can make demand very inelastic. So can a narrow emergency. A stranded traveler may have inelastic demand for a ride. A patient with a life-preserving medicine may have extremely inelastic demand. Market definition matters too: "food" is broad and inelastic, while "one brand of cereal" is narrow and more elastic.

Now, note that it's only a rule of thumb: technically, elasticity is a sanitized, sterile measure of what happens to one thing when the other thing happens, and that's it. But it's a great way to form intuitions about how elasticity works in practical terms.

Can a good have high elasticity even with few direct substitutes? Yes. There is one choice that should be added to every standard list of substitutes, but is often missing: the choice to walk away. The cleanest substitute for any product isn't a rival brand—it's going without. This is the choice of non-consumption. Choosing not to consume puts a ceiling on every price: at some point, you can't raise the price forever or people will simply leave. When demand is elastic, it doesn't necessarily mean better options exist; it often means consumers are simply willing to keep their money in the bank. When going without is easy, demand stays elastic and prices stay disciplined. When going without is impossible—whether due to survival, addiction, or a complete lack of alternatives—the option to walk away disappears, and prices can float high.

The total revenue test is a quick way to infer price elasticity of demand by observing what happens to a seller’s total revenue when price changes.

TR = P × Q

The total revenue test works because it balances two competing effects of a price change. We can informally refer to these as the price effect and the quantity effect. The price effect is the change in revenue from receiving more or less per unit. The quantity effect is the change in revenue from selling fewer or more units.

Imagine you're a seller of an elastic good, say restaurant meals, and you lower your price: because buyers are responsive, they flock to your cheaper offering. You lose a little less for each sale, but that effect is swamped by the quantity effect: you get way more revenue than you lose by lowering the price. Contrariwise, imagine you're a provider of inelastic goods, perhaps eggs. You lower your price by 20% and behavior doesn't shift, so you end up with less revenue. All because eggs are a staple that aren't very responsive to price shifts.

Note that it is straightforward to flip this table: if price falls then you simply reverse the rest as follows.

Elasticity and slope: One nifty property of elasticity is that you can get a good sense of an elasticity just by looking at the relatively slope of the related curve. For example, on graphs drawn with the same units and scale, a flatter (more horizontal) demand curve indicates greater relative elasticity, which you can tell simply by looking at it. Similarly, a steeper curve tells you that something is inelastic at-a-glance — meaning a large change in price is required to shift quantity even a little.

Be careful, however. Slope is not the same as elasticity. While slope and elasticity are related, they are fundamentally different metrics. First, slope is a ratio of absolute units whereas elasticity is a unitless ratio of percentage changes. Second, because the variables are inverted on standard axes—with Price on the vertical axis and Quantity on the horizontal axis—slope measures absolute change in price per unit change in quantity, whereas elasticity captures proportional responsiveness. As a result, even though a linear demand curve maintains a constant slope throughout its entire length, its elasticity changes continuously, moving from elastic at higher prices to inelastic at lower prices.

Slope: $\frac{\Delta P}{\Delta Q}$ (change in price divided by change in quantity)

Elasticity: $\frac{\%\Delta Q}{\%\Delta P}$ (% change in quantity divided by % change in price)

It's worth saying that again. In real economics we rarely see a linear demand curve, but they are useful models for introductory students. If a demand curve were linear, it would imply a constant tradeoff in price and quantity. Using the image below, a $5 change in price will result in change of 10 pizzas demanded, and this is true at any point on the line. But elasticity is a relative measure. In the image below, you can see that elasticity changes continuously across the same linear demand curve because elasticity is calculated using percentages. If you look at absolute units, a five-dollar increase in price yields a decrease of 10 units in quantity demanded everywhere along the curve, meaning the slope is constant. But because elasticity relies on percentage changes, the actual responsiveness changes depending on where you start on the curve.

Now that we understand elasticity, we can begin to attack the issue of tax incidence.

You will recall from a previous chapter about the intent and outcomes of the yacht tax of 1990. Passed as part of the Omnibus Budget Reconciliation Act of 1990, the federal government's 10% luxury tax on new yachts priced over $100,000 stands as a classic case of ignoring price elasticity. Lawmakers had hoped to tax yachts, targeting the wealthiest multi-millionaires who could afford high-end vessels. Whether on purpose or not, they made the assumption of completely inelastic demand: this tax will hit the wealthy, and only the wealthy. The wealthy would simply pay the extra tax without flinching. Instead, because luxury goods typically have high price elasticity, wealthy buyers drastically altered their behavior: they delayed purchases, bought used boats, or went abroad to acquire and moor their vessels internationally.

Consequently, domestic yacht sales plummeted by double digits, and the tax brought in a fraction of its projected revenue while triggering massive layoffs across American boatyards. The ultimate burden fell priamrily on blue-collar shipwrights, fiberglass technicians, and marine mechanics who lost their livelihoods, proving that when policymakers misjudge elasticity, a tax meant for the upper crust ends up crushing the working class. Realizing the policy had actually cost the government money in unemployment benefits and lost income taxes, Congress repealed the yacht tax three years later.

Tax incidence asks who actually bears a tax. Remember: tax incidence is about who really pays, not who signs the check. In other words, tax incidence is not always the same as legal incidence. A government can require sellers to send in the tax, but sellers may raise prices. Or a government can legally tax buyers, but sellers may have to lower prices to keep sales.

The rule is simple: those who can escape the purchase also escape the tax. The more inelastic side of the market bears more of the tax burden. Inelastic means fewer exits. If buyers cannot walk away, buyers pay more. If sellers cannot shift production elsewhere, sellers absorb more.

This webpage has an excellent widget that will let you try this out. Remember the key rule: whichever side is more inelastic cannot escape, and will end up paying the larger share of the tax. (Seriously, try it.)

Now, a brief synthesis. What does elasticity mean from each perspective?

Seller: Providing an inelastic good means that a seller facing the right market conditions may be able to raise prices without losing many customers. Conversely, selling an elastic good leaves a seller vulnerable to even small price undercuts from competitors, because consumers can easily switch.

Government: If the goal of a tax is to change behavior, governments generally want consumers to be responsive to price. If the goal is to generate reliable revenue, they prefer a relatively inelastic tax base, because consumption will remain more stable after the tax is imposed.

Buyer: Operating in an elastic market gives you room to escape price increases by switching, delaying, or going without. Participating in an inelastic market leaves you with fewer practical alternatives, especially when the good is a necessity.

Here's a way to remember it from the government's perspective: if you want to change behavior, tax elastic goods. If you want to generate revenue, tax inelastic goods.

Price elasticity of supply (or PES) measures how strongly sellers respond to price changes. Supply is more elastic when firms can expand or reduce production quickly. Supply is more inelastic when capacity, land, technology, permits, contracts, or time make adjustment hard.

As an example, if the price of nuclear energy skyrocketed, I might be inclined to join the market as a seller to maximize my profits. Unfortunately, nuclear energy is rather difficult for me to scale up quickly. On the other hand, when the price of eggs recently skyrocketed a number of friends worried that the higher price would "become the new normal." I told them not to fret, price elasticity of supply to the rescue! And I turned out to be right: several families in the area bought chickens, started selling eggs, and eventually the larger factories began expanding production again.

Supply elasticity matters for tax incidence because sellers can also escape. If sellers can shift production to another market, they may avoid bearing much of a tax. If they cannot, they may absorb more of it. A beachfront hotel cannot move the beach. A software company can often shift effort more easily.

Throughout this book we've talked about normal, inferior, and luxury goods, as well as substitutes and complements. Now we can use elasticity to make formal definitions of each of them.

Cross-price elasticity (XED) measures how demand for one good responds when the price of another good changes. If the cross-price elasticity is positive, the goods are substitutes: when the price of one rises, demand for the other rises. If it is negative, the goods are complements: when the price of one rises, demand for the other falls.

Income elasticity (YED because Y refers to income in many economics equations) measures how demand responds when income changes. Normal goods have positive income elasticity. Inferior goods have negative income elasticity. Luxury goods often have income elasticity greater than one because demand grows more than proportionally as income rises.

Jeremiah Johnson recently posted a rather entertaining thread on X wherein he documents some of the more hilarious things for which capitalism has been blamed in recent years. His viral thread rounded up a whole museum of the genre, which is worth a scroll. A sampler of the charges:

• Capitalism makes you go to work.
• Capitalism made weed legal.
• Capitalism is why you are lonely.
• Capitalism is why a (state-owned) business lit the ocean on fire.
• Capitalism may have ended life on mars (courtesy of a former head of state).
• And, finally, capitalism might be why they are making weed illegal.

In the first place, it's worth defining our terms. What is capitalism? The term was originally used by Marx and others to deride those who invested their money and made fortunes. Today, even the most grudging marxist recognizes that financialization is one of the primary reasons for our economic success. Moreover, it was not capitalism that brought that success, but something significantly simpler: personal economic freedom. When people have the right to own property, invest their money, and build their own businesses, nations become very wealthy very quickly.

The critiques I listed can be a genuine delight to read. Almost none of them survive this single follow-up: compared to what? Economist Thomas Sowell was famous for insisting that no policy should ever be evaluated on its own, or it would be subject to the nirvana fallacy: the notion that with the right policy we could eliminate poverty, crime, or disease. A person could say "the modern US accepts homicides at a rate of 5 per 100,000, are you comfortable with that?!" Compared to the 1500s, of course, that rate is a fraction of what it once was.

Greed, inequality, crime, and the grind of working to eat are real, and they are old — older than markets by millennia — and no economic system yet invented has abolished them. Personal economic freedom remains the most important ingredient in prosperity that we have ever seen.

It is easy, and satisfying, to line the foolish critiques up and knock them down. This is called strawmanning: building a weak opponent, just to knock them down. But it is also a trap, because the reflex that waves away a silly complaint will wave away a serious one just as fast. Markets are the goose that laid the golden egg, and we owe that goose two things at once. We owe it a defense — the prosperity it produced is no accident, and it is worth guarding from lazy attacks. And we owe it honesty about where it falls short, because a goose you refuse to examine is a goose you will eventually lose. This book will attempt to do the second thing, and to do it on the market's own terms.

Most critiques worth taking seriously ask whether the engine is broken. Are there external costs? Is information missing? Is competition absent? Are property rights unclear? Those are the questions the rest of the book takes up, one at a time. But this chapter asked a stranger one: what if there is a problem when the engine is running perfectly ?

Elasticity and efficiency are powerful positive tools. They tell us how people respond to prices, who bears a tax, and whether a market captures the gains from trade. But they do not answer every question we care about.

Elasticity measures responsiveness — but read it closely and it also measures options: how easily a person can switch, delay, substitute, or simply walk away. When demand is elastic, buyers have somewhere else to go. When demand is inelastic, they may have almost nowhere, even while they remain technically free to choose. That is the quiet, uncomfortable lesson of this chapter: choice is not always abundant. Sometimes choice can be thin.

A family in need of insulin might be in a completely competitive market. They might exist in Adam Smith's dream market, or even Milton Friedman's. A competitive market does not guarantee that everyone will be able to afford the life-saving insulin they need.

Fortunately, when options are thin, we have an easy response: aim to build more options. Another way to say it is this: restore exit before you trust the price. Entrepreneurs can discover substitutes and cheaper ways to deliver an essential good. Policymakers can lower barriers to entry and let competition do its work. Insurance or public provision can reach places competition alone cannot. None of these is automatically right, and which one fits depends on why the choices are thin — but the principle holds: when people have no way to escape a price, widening their options improves both their freedom and their welfare.

The first critique of the market is that it will not solve every problem. Under the right conditions, however, markets are extraordinarily powerful tools for coordinating activity, encouraging innovation, and capturing gains from trade. They may well be the most effective way to maximize our progress in solving them. Will some people still go without? Yes. But, according to both theory and empirical evidence, economic freedom produces powerfully positive outcomes so long as our assumptions hold.

What elasticity cannot tell us is whether a given burden is acceptable . It cannot tell us whether insulin should be subsidized, whether a tax on an addictive good is fair, or whether a particular price reflects real costs or raw market power. Those questions belong to history, philosophy, religion, political theory, and moral reasoning.

Economics can find the places where people have little room to move. It can show us who bears a burden, how behavior will shift, and what a policy will cost. It can walk us right up to the edge of the decision. It cannot make the decision for us. Efficient and good are two different words, and no amount of arithmetic turns one into the other.