David R. Henderson  

Mankiw's Textbook on Determinants of Demand Elasticity

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In the Energy Economics course I'm teaching this quarter, I have a number of students who have never had economics before. So I'm using selected chapters from the Microeconomics portion of Greg Mankiw's Principles of Economics, and I add a few dozen readings from the literature, especially from the literature on energy. I use the 5th edition of Mankiw so that the students spend closer to $20 than to $150.

I like the book, which is why I use it, but each time I use it, I find things that are off. This is about one of those.

In a section on determinants of elasticity of demand, Mankiw lists four. The first is "Availability of Close Substitutes." The third is "Definition of the Market."

Here's Mankiw:

Availability of Close Substitutes
Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others. For example, butter and margarine are easily substitutable. A small increase in the price of butter, assuming the price of margarine is held fixed [by the way, this is not my criticism, but some students will read that as "assuming the government keeps the price fixed," when what he really means is "assuming the price of margarine doesn't change"] causes the quantity of butter sold so fall by a large amount. By contrast, because eggs are a food without a close substitute, the demand for eggs is less elastic than the demand for butter."

Definition of the Market
The elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. For example, food, a broad category, has a fairly inelastic demand because there are no good substitutes for food. Ice cream, a narrower category, has a more elastic demand because it is easier to substitute other desserts for ice cream. Vanilla ice cream, a very narrow category, has a very elastic demand because other flavors of ice cream are almost perfect substitutes for vanilla.

On their own, each of these is fine. The problem is that Mankiw never makes it clear that they are the same point. Notice how he discusses the definition of the market. It's all about close substitutes, which is the point of his "Availability of Close Substitutes" point.


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COMMENTS (14 to date)
JLV writes:

There is an overlap, but they are not entirely the same: different broad categories can have different elasticities depending on close substitutes available for these broad categories.

I.e. holding the breadth of the market fixed, there is still variation in elasticities.

Brent writes:

All the reasons are about the availability of substitutes in the mind of the consumer. Luxury vs. Need Goods... Addictive vs. Non-Addictive Goods. High Cost (as % of income) Good are more elastic, ceteris paribus, because there are more alternative things that could be purchased, the higher the price of a good.

AMW writes:

In my Econ class I combine these into a talk about the number of close substitutes. As part of that discussion I point out that the market demand curve is always less elastic than any firm's demand curve (unless it's a monopoly) because it's easier to substitute one gasoline brand for another, say, than to substitute out of gasoline altogether. Consequently, a market demand curve shows what would happen if ALL gas stations raised their prices simultaneously, while a gas station's demand curve shows what would happen if it raised its price while none of its competitors did.

Philo writes:

@JLV:

If you have a definition of 'breadth', as an absolute concept, please let us have it! The market for ice cream is obviously broader than the market for vanilla ice cream, but is it broader or narrower than the market for shoes, or the market for ball bearings, or . . .?

Edogg writes:

I applaud your concern for your students' budgets. Maybe high textbook prices are mostly mitigated by their resale value, but it was at least obnoxious to be forced to spend so much on textbooks when I was a student.

GM writes:

The availability of used textbooks means the demand for new textbooks is (somewhat) more price elastic.

Pemakin writes:

Your point was modestly interesting. I would be interested to know whether Mankiw fixed that problem in later slightly changed editions.

More interestingly, i would like to hear your views and his on the economics and ethics of textbook usage. I think its among the biggest ripoffs we have

Rick Hull writes:

I think Mankiw has a nice insight here, but Henderson is right that these two determinants are not distinct peers. The presentation / organization is off. At the bottom is the question of close substitutes. To restate Mankiw's insight, I would say that broader goods categorizations tend to have less close substitutes. This is a useful insight, and the butter vs eggs, and food vs vanilla ice cream examples illustrate well.

Mark V Anderson writes:

Everybody else seems to get it this post, but I don't. Maybe because I don't regularly read econ textbooks like some of the rest of you? As you say, they both sound reasonable on their own, so why are they poor together? Maybe because focusing on substitutes is too narrow for a definition of markets? I generally think that repeating the same concept in different ways is a good way to teach.

I too am impressed with your concern about students' costs. Even at my daughter's community college, the text costs are amazingly high.

Will writes:

Doesn't all of the substitute/complementary notion go against the "never reason from a price change" phrase. i.e. if the price of butter falls because of a fall of demand for it, why would the quantity of margarine increase? Unless of course there is some external factor. This becomes even more evident with complements.

Mark Brady writes:

How about the argument that a consumer could regard two very different goods, e.g., a new purse and a new pair of shoes, as substitutes when spending, say, a hundred dollars of discretionary income, yet the market for purses and the market for shoes are regarded as discrete markets?

EclectEcon writes:

As you know, I did the Canadian Edition of Paul Heyne's marvelous text, The Economic Way of Thinking. In his text, Paul had what we called "marginalia" -- little phrases that were germane but were not summaries or notes. In this section of the Canadian edition, I added:

"There's no business like show business." - Ethel Merman.

"There are plenty of businesses like show business." - Bart Simpson.

Craig Brown writes:

Would you be so kind as to send/post a link to your syllabus for the course? I'd like to peruse the readings list.

Market Fiscalist writes:

Having learned economics mainly by reading bloggers like David I was inspired by this post to check out used editions of Mankiw's Textbook and bought a 5th edition for just under $10.

I spent the last few hours reading it.

$10 very well spent.

BTW: David , really enjoy your posts.

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