AAEC 3315 Agricultural Price Theory

Chapter 9 Market Supply and Elasticity

Objectives

 To learn:  How Market Supply is determined.

 Elasticity of Supply  Price Elasticity of Supply  Cross-Price Elasticity of Supply

Market Supply

 Earlier, we discussed that the individual firm’s supply curve was the firm’s MC curve above AVC  The total offered by all firms in the market can then be derived by aggregating each firm’s supply curve.

Market Supply

 As with demand, the supply curve for a good in the market is the horizontal sum of all individual firm’s supply curves.

P P 2  Market Supply - is the various amounts of a good that producers are

willing & able

to produce and supply at different price levels during a specified period of time.

P 1 S1 S2 Market Supply Q 11 Q 21 Q 12 Q 22 Q 1M Q 2M Q

Elasticity of Supply (E

s

)

 Managers are interested in two types of supply elasticity measures:  Own-price elasticity of supply - measures the responsiveness of quantity supplied of a good to a change in the price of that good.

 Cross-price elasticity of supply - measures the responsiveness of quantity supplied of a good to a change in the price of a related good.

Elasticity of Supply (E

s

)

 Price Elasticity of Supply is defined as the percentage change in the quantity supplied relative to the percentage change in price.

 It is a measure of responsiveness of quantity supplied to changes in price.

 Calculating Own Price Elasticity of Supply from a Supply Function:  Using calculus:

E sy

 

Q sy



P y



P y Q sy

Elasticity of Supply (E

S

)

 Given a supply function: Q sy = -900 + 150 P, where, Q product Y and P y sy = Quantity supplied of = Price of product Y ($30 per unit).

 Q sy = -900 + 150*(30) = 3600 units  Taking partial derivative of the supply function with respect to price and substituting values for P and Q s :

E sy

 

Q sy



P y



P y Q sy

 ( 150 )  30 3600  1 .

25

Elasticity of Supply (E

s

)

 Interpretation  E s = 3: If the price of the product changes by 1% then the quantity supplied of the product changes by 3%  E s = 1: If the price of the product changes by 1% then the quantity supplied of the product changes by 1%  E s = 0.37: If the price of the product changes by 1% then the quantity supplied of the product changes by 0.37%

Elasticity of Supply (E

s

)

 Classifications:  Inelastic supply (E s < 1): a change in price brings about a smaller change in quantity (we are less responsive to price)  Unitary Elastic supply (E s = 1): a change in price brings about an equivalent change in quantity.

 Elastic supply (E s >1): a change in price brings about a relatively larger change in quantity.

Cross-price Elasticity of Supply

 Measures the effect of a change in the price of good X on the quantity supplied of Y.

 Using Calculus from a Supply function:

E syx

 

Q sy



P x



P x Q sy

 Read this as the cross-price of elasticity of supply for product Y with respect to price of product X.

Interpretation & Classification of Cross-price elasticity of Supply

 Interpretation:  E SYX =1.5 implies that as price of X changes by 1%, the quantity supplied of Y changes by 1.5%.

 Classification:  Complements in production (E SYX >0): implies that as the price of X increases, the quantity of Y supplied by the firm will increase.

 Substitutes in production (E SYX <0): implies that as the price of X increases, the quantity of Y supplied by the firm will decrease.