Transcript Elasticity of Demand & Supply

Elasticity of Demand &
Supply
Chap 18- Extensions of Demand &
Supply Analysis – McConnel & Brue
Chap 2-The Basics of Demand &
Supply – Pindyck
Lecture 7
Price Elasticity of Supply: The
Market Period
• The market period is the period that occurs
when the time immediately after a change in
market price is too short for producers to
respond with a change in quantity supplied.
• E.g. the supply for tomatoes is perfectly inelastic
(vertical); the farmer will sell the truckload
whether the price is high or low.
• The farmer does not have time to respond to a
change in demand from D1 to D2 (p349-Ch18)
Price Elasticity of Supply: The
Short Run
• The short run is a period of time too short to
change plant capacity but long enough to use
fixed plant more or less intensively
• The farmer does have time in the short run to
cultivate tomatoes more intensively by
employing more labor, more fertilizer and
pesticides to the crop- even though his land and
machinery is fixed
• The result is greater output in response to an
increase in demand, as supply of tomatoes is
more elastic.
Price Elasticity of Supply: The Long
Run
• The long run is a time period long enough for
farmers to adjust their plant sizes for new firms
to enter (or exit) the industry
• The farmer has time to acquire additional land
and buy more machinery and equipment
• Other farmers may switch to tomato farming in
response to the increased demand – Therefore
supply curve is more elastic than short run
Supply & Total Revenue
• There is no total revenue test for elasticity
of supply
• Supply shows a positive or direct
relationship between price and amount
supplied
• Regardless of the degree of elasticity or
inelasticity, price and total revenue always
move together.
Predicting the Effects of
Changing Market Conditions
• Let’s begin with the equations for supply,
demand, elasticity:
– Demand: Q = a – bP
– Supply: Q = c + dP
– Elasticity: (P/Q)(Q/P)
• We must calculate numbers for a, b, c,
and d.
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Predicting the Effects of
Changing Market Conditions
• The slope of the demand curve above
equals Q/P which equals -b
• The slope of the supply curve above
equals Q/P which equals d
Demand: ED = -b(P*/Q*)
Supply: ES = d(P*/Q*)
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Predicting the Effects of
Changing Market Conditions
Price
Supply: Q = c + dP
a/b
ED = -bP*/Q*
ES = dP*/Q*
P*
Demand: Q = a - bP
-c/d
Q*
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Quantity
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Predicting the Effects of
Changing Market Conditions
• Using P*, Q* and the elasticities, we can
solve for b and c from supply
ES = d(P*/Q*)
1.6 = d(0.75/7.5) = 0.1d
d = 16
Q = c + dP
7.5 = c + (16)(0.75) = c + 12
c = -4.5
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Predicting the Effects of
Changing Market Conditions
• Using P*, Q* and the elasticities, we can
solve for a and b from demand
ED = –b(P*/Q*)
-0.8 = -b(0.75/7.5) = –0.1b
b=8
Q = a – bP
7.5 = a – (8)(0.75) = a – 6
a = 13.5
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Predicting the Effects of
Changing Market Conditions
• We now have equations for supply and
demand
Supply: Q = –4.5 + 16P
Demand: Q = 13.5 – 8P
• Setting them equal will give us equilibrium
price and quantity with which we began
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Predicting the Effects of
Changing Market Conditions
Price
Supply: QS = -4.5 + 16P
a/b
.75
Demand: QD = 13.5 - 8P
-c/d
7.5
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Mmt/yr
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Predicting the Effects of
Changing Market Conditions
• We have written supply and demand so
that they only depend upon price
• Demand could also depend upon other
variables such as income
• Demand would then be written as:
Q  a  bP  fI
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Consumer & Producer Surplus
• The difference between the maximum
price a consumer is willing to pay for a
product and the actual price (p352-Ch 18)
• Producer Surplus is the difference
between the actual price a producer
receives and the minimum acceptable
price
• Productive efficiency is achieved because
competition forces producers to use the
best techniques and combinations of
resources in producing goods
• Allocative efficiency is achieved because
the correct quantity of output is produced
relative to other goods and services
• Demand Curve measures marginal benefit
of oranges at each level of output
• Supply Curve measures marginal cost
Allocative Efficiency
• Allocative Efficiency :
– MC = MB
– Maximum willingness to pay = minimum acceptable
price
– Combined consumer and producer is at its maximum
• Where maximum willingness to pay for the last
unit equals minimum acceptable price for that
unit, does the society exhaust all the
opportunities to add to combined consumer and
producer surplus
Short-Run Versus Long-Run
Elasticity
• Most goods and services:
– Long-run price elasticity of supply is greater
than short-run price elasticity of supply
• Other Goods (durables, recyclables):
– Long-run price elasticity of supply is less than
short-run price elasticity of supply
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Short-Run Versus Long-Run
Elasticity
SSR
Price
SLR
Due to limited
capacity, firms
are limited by
output constraints
in the short run.
In the long run, they
can expand.
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Chapter 2
Quantity Primary Copper
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Short-Run Versus Long-Run
Elasticity
SLR
Price
SSR
Price increases
provide an incentive
to convert scrap
copper into new supply.
In the long run, this
stock of scrap copper
begins to fall.
Quantity Secondary Copper
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Short-Run Versus Long-Run
Elasticity
• Price elasticity varies with the amount of
time consumers have to respond to a price
• Short-run demand and supply curves often
look very different from their long-run
counterparts
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Short-Run Versus Long-Run
Elasticity
• Demand
– In general, demand is much more price elastic
in the long run
• Consumers take time to adjust consumption habits
• Demand might be linked to another good that
changes slowly
• More substitutes are usually available in the long
run
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Gasoline: Short-Run and Long-Run
Demand Curves
Price
DSR
• People cannot easily
adjust consumption in
the short run.
• In the long run, people
tend to drive smaller and
more fuel efficient cars.
DLR
Quantity of Gas
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Short-Run Versus Long-Run
Elasticity
• Demand and Durability
– For some durable goods, demand is more
elastic in the short run
– If goods are durable, then when price
increases, consumers choose to hold on to
the good instead of replacing it
– But in long run, older durable goods will have
to be replaced
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Cars: Short-Run and Long-Run
Demand Curves
Price
DLR
• Initially, people may put
off immediate car
purchase
• In long run, older cars
must be replaced
DSR
Quantity of Cars
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Short-Run Versus Long-Run
Elasticity
• Income elasticity also varies with the
amount of time consumers have to
respond to an income change
– For most goods and services, income
elasticity is higher in the long run
– When income changes, it takes time to adjust
spending
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Short-Run Versus Long-Run
Elasticity
• Income elasticity of durable goods
– Income elasticity is smaller in the long run
than in the short run
• Increases in income mean consumers will want to
hold more cars
• Once older cars are replaced, purchases will only
be to replace old cars
• Less purchases from income increase in long run
than in short run
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