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This is a point I find very confusing and very hard to justify to students. Depending on the books, one finds many different conventions regarding the sign of elasticities and marginal rate of substitution (MRS). Some define them taking absolute value, some don't, and one sometimes finds inconsistencies inside a single book or set of notes.

My questions are :

  • To your knowledge, what is the most conventional stance regarding the use of absolute value in the definition of
    • Own-price elasticity
    • Cross-price elasticity
    • MRS
  • Is it mere convention or is there somewhat of a rational for taking absolute value in some/all/none of the cases?
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3 Answers 3

up vote 6 down vote accepted

I think there are pedagogical advantages to discussing both the raw numbers and the absolute values and I think the benefits of both explain why they both show up (sometimes in the same text, even).

Each elasticity number gives two bits of information. First, the absolute value with respect to 1 and second, the sign. Now, clearly, if you had a negative elasticity, you could compare it to -1. However, it becomes somewhat difficult to teach when using phrases like "greater than" or "less than" -1 to discuss a good being (in)elastic, since "greater than -1" is actually inelastic if the elasticity is negative. It is much more intuitive to be able to discuss the ratios of percent changes if "greater than" does in fact mean that the top is bigger than the bottom and vice versa for "less than".

Of course, there is also a bunch of information tied up in the sign of the elasticity. We get the Law of Demand out of own-price elasticity, we get compliments/substitutes from cross-price elasticity, etc. So it is important to still make sure students understand the importance of the sign.

When I am teaching, I try to discuss both parts explicitly, but make clear that the elasticity itself includes the appropriate sign. I think most books are trying to capture these two bits of information in one way or another. In any case, the formal definition of elasticity should include the sign, but if one is just talking about how elastic a good is, the absolute value could be reported (with the note that it is the absolute value of the elasticity, not the elasticity itself).

As for MRS, it's usually not the absolute value, per se, that we report, but rather the negative of the derivative dy/dx. This is quite standard, since it has the intuitive interpretation of the consumer being willing to give up so many units of x for so many units of y. Since indifference curves are usually convex, this derivative is negative, thus changing the interpretation (and intuition) somewhat if we don't negate it.

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Related to the MRS, this is a more general problem regarding negative slopes. I confess to continuously being confused for many-many years on the matter (and having to pose and think), until I constructed the following mental image in my mind, which I share here just in case somebody else may find helpful:

enter image description here

The trick is to put minus and plus infinity side-by-side on top, and imagine straight lines rotating following the arrows.

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Can't resist this quote from Samuelson, though I'm afraid it's not very helpful:

Through the influence of Alfred Marshall economists have developed a fondness for certain dimensionless expressions called elasticity coefficients. On the whole, it appears their importance is not very great except possibly as mental exercises for beginning students.

From: Foundations of Economic Analysis, 1947, p. 125

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