Elasticity measures the responsiveness of one variable to changes in another. The most common form is price elasticity of demand, calculated as the percentage change in quantity demanded divided by the percentage change in price: \(E_d = \frac{\%\Delta Q_d}{\%\Delta P}\). When the absolute value of this ratio exceeds one, demand is elastic and quantity is highly responsive to price. When it is less than one, demand is inelastic and quantity is relatively unresponsive. The unit elastic case, where the ratio equals one, describes situations in which percentage changes in price and quantity are equal.
Several factors shape elasticity. The availability of substitutes is critical: goods with many close alternatives tend to have more elastic demand than goods without them. Necessities typically display inelastic demand while luxuries display elastic demand. Goods that consume a large share of consumer income tend to have more elastic demand, and demand generally becomes more elastic over longer time horizons as consumers adjust habits and find alternatives. Cross-price elasticity measures the responsiveness of demand for one good to changes in the price of another. Positive cross-price elasticity indicates substitutes, while negative cross-price elasticity indicates complements, goods consumed together.
Income elasticity measures how demand responds to changes in consumer income. A normal good has positive income elasticity, so demand rises with income, while an inferior good has negative income elasticity, so demand falls as income rises. Two special cases defy the law of demand. A Giffen good is a rare inferior good whose demand rises as its own price rises, because a strong income effect outweighs the substitution effect. A Veblen good is a luxury whose demand rises with price because higher prices confer status. These cases reveal that demand is shaped by psychological and social forces in addition to straightforward price comparisons, foreshadowing the behavioral economics discussed in the next chapter.