Download Elasticity of Supply 107 perfectly elastic supply

Elasticity of Supply
107
Perfectly Elastic and Perfectly Inelastic Supply. As in the case of demand.
perfectly elastic supply:
there can be perfectly elastic supply or perfectly inelastic supply, as shown in
supply for which the price
Figure 9. The vertical supply curve is perfectly inelastic; it has zero elasticity. Such
elasticity is infinite, indicating
supply curves are not unusual. For example, there is only one Mona Lisa. A higher
an infinite response of quantity price cannot bring about a higher quantity supplied, not even one more Mona Lisa.
supplied to a change in price and But the supply curve for most goods is not vertical. Higher prices will encourage
therefore a horizontal supply
coffee producers to use more fertilizer, hire more workers, and eventually plant more
curve.
coffee trees. Thus the quantity supplied increases when the price rises.
perfectly inelastic supply:
The horizontal supply curve is perfectly elastic. In this case, the price does
supply for which the price
not change at all. It is the same regardless of the quantity supplied. It is easier
elasticity is zero, indicating no to understand the horizontal supply curve if you view it as an approximation to a
response of quantity supplied to a supply curve that is nearly horizontal, one with a very high elasticity. Then only
change in price and therefore a a small increase in price brings forth a huge increase in the quantity supplied
vertical supply curve.
by firms.
Why the Size of the Price Elasticity of Supply Is Important. Now let us
look at the importance of knowing the size of the supply elasticity even if it is not at
one of these two extremes. Figure 10 shows two different supply curves for coffee.
The horizontal axis shows the quantity of coffee supplied around the world in
billions of pounds; the vertical axis shows the price in dollars per pound of coffee. For
the supply curve in the top graph, the quantity supplied is very sensitive to the price;
the price elasticity of supply is high. For the supply curve in the bottom graph, the
price elasticity of supply is much lower.
PRICE
Perfectly inelastic
supply
\
Perfectly elastic
supply
QUANTITY SUPPLIED
FIGURE 9
Perfectly Elastic and Perfectly Inelastic Supply
When the quantity supplied is completely unresponsive to the price.
the supply curve is vertical and the price elasticity of supply is zero; this
case is called perfectly inelastic supply. When the quantity supplied
responds by large amounts to a price change, the supply curve is
horizontal; economists then say that supply is perfectly elastic.
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CHAPTER 4 Subtleties of the Supply and Demand Model: Price Floors, Price Ceilings, and Elasticitv
COFFEE PRICE
(DOLLARS PER POI ND)
Quantity supplied is very
sensitive to the price.
Supply curve w ith a high
price elast icily of supply
1411
COFFEE PRICE
(DOLLARS PER POUND)
QUANTITY SUPPLIED
(BILLIONS OF POUNDS OF COFFEE)
Supph cune with a low
price elasticity of supply
Quantity supplied is not
very sensitive to the price.
140
Ql.O
' TITV SUPPLIED
(BILLIONS OF POUNDS OF COFFEE
FIGURE 10
Comparing Different Sizes of the Price Elasticities of Supply
In the top graph, the quantity supplied is much more sensitive to price than in the bottom graph
The price elasticity of supply is greater between points A and B at the top than between points A
and Cat the bottom.
The price elasticity of supply is important for finding the response of price to
shifts in demand. This is shown in Figure 11. where the demand for coffee declines.
perhaps because of concerns about the effect of the caffeine in coffee or because of a
decrease in the price of caffeine-free substitutes for coffee. In any case, if the price
elasticity of supply is high, as in the top graph, the price does not change as much as
when the price elasticity of supply is low. as in the bottom graph. With a high price
elasticity, a small change in price is enough to getfirmsto bring the quantitv supplied dow n to the lower quantity demanded.
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Elasticity of Supply
109
COFFEE PRICE
(DOLLARS PER POUND)
Supply curve with
high elasticity
3.00
2.00
1.00
..leads tn a smal
change in price.
COFFEE PRICE
D
( OLLARS PER POUND)
Old demand
New demand
10I 0
12I 0
140
QUANTITY
(BILLIONS OF POUNDS OF COFFEE)
Supply cune with
low elasticity
:l.(lll
2.011
FIGURE 11
Importance of Knowing the
Size of the Price Elasticity of
Supply
When demand changes, the price will
also change. If the price elasticity of
supply is high, there will be a small
change in price. II the price elasticity
of supply is low, there will be a large
change in price.
1.00
so
Old demand
New demand
1I00
12
I0
140
QUANTITY
(BILLIONS OF POI NDS OF COFFEE)
R E V I E W
-The price elasticity of supply is a number that tells us how sensitive the quantity
supplied is to the price. It is defined as the percentage change in the quantity
supplied divided by the percentage change in the price.
• The attractive features of the price elasticity of demand are also true for the
price elasticity of supply. Its size does not depend on the units of measurement
of either price or quantity.
• The price elasticity of supply is useful for determining how much prices will
change when there is a change in demand.
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CHAPTER 4 Subtleties of the Supply and Demand Model: Price Floors, Price Ceilings, and Elasticity
CONCLUSION
In this chapter, we have extended our analysis of the supply and demand model in
two directions. We first learned about what happens when the government intervenes to put a price ceiling or a price floor into the economy. Understanding howto use the supply and demand model with price floors and ceilings enables us to
better understand policy debates such as the one surrounding the increase in the
minimum wage.
The second extension was to develop an understanding of how much the equilibrium price and quantity change in response to changes in supply or demand.
The concept of price elasticity of demand helps us understand what happens to the
quantitv demanded when there is a change in price or when there is a change in the
supph of a good. We can also predict whether revenue will increase or decrease when
prices are cut or raised. The related concept of the elasticity of supply is also useful in
understanding what happens to the quantity supplied when there is a change in
price or when there is a change in the demand for a good. We also discussed the concept of an income elasticity of demand, which can help clarify how the quantity
demanded for various goods w ill change as incomes rise, and the cross-price elasticity of demand, which tells us how much the quantity demanded of a good changes as
prices for substitute or complementary goods change.
KEY POINTS
1. Governments will occasionally intervene in markets
sophisticated analysis of minimum-wage law s, for
because they think that the equilibrium price is too
example, than we have done so far in this chapter.
high or too low. When they act to impose a maximum 4. Elasticity is a measure of the sensitivity of one
price on a market, because they think the price that
economic variable to another. For example, the price
buyers have to pay is too high, they are said to be
elasticity of demand measures how much the
imposing a price ceiling. When they act to impose a
quantity demanded changes w hen the price
minimum price on a market, because they think the
changes.
price that sellers are receiving is too low, they are said 5. Elasticity is a unit-free measure. The price elasticity
to be imposing a price floor.
of demand is the percentage change in the quantitv
2. Price ceilings cause shortages, with the quantitvdemanded divided by the percentage change in
supplied being less than the quantity demanded.
price. It refers to changes in price and quantitv
Shortages lead to rationing or black markets. Price
demanded along the demand curve, all other things
floors cause surpluses, with the quantity supplied
being equal.
being greater than the quantity demanded. Surpluses 6. Demand is said to be elastic if the price elasticity of
lead to resources being diverted away from other
demand is gteater than 1 and inelastic if the price
productive activities to deal with the extra output
elasticity of demand is less than 1.
that needs to be stored or disposed of.
7. When the elasticity is greater than 1. an increase in
3. Rent controls are a classic application of a pricethe price reduces the quantity demanded by a
ceiling, and minimum wages are a classic application
percentage greater than the percentage increase in
of a price floor. The supph' model helps us
the price, thereby reducing revenue. When the
understand some basic issues related to these
elasticity is less than 1. an increase in the price
policies, which frequently appear in the news today.
reduces the quantity demanded by a percentage less
We will go on to develop the supply and demand
than the percentage increase in the price, thereby
model further, which will allow us to do a more
increasing revenue.
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Problems
111
and have a positive income elasticity of demand.
8. The elasticity of demand for a good depends on
Inferior goods have a negative income elasticity
whether the good has close substitutes, whether its
of demand.
value is a large or a small fraction of total income,
10. The price elasticity of supply is defined as the
and the time period of the change.
percentage change in the quantity supplied divided
9. Whereas the price elasticity of demand refers to
by the percentage change in the price. If a good has a
movements along the demand curve, the income
high price elasticity of supply, then a change in price
elasticity of demand refers to shifts in the
will cause a big change in the quantity supplied.
demand curve caused by changes in income,
Conversely, if a good has a low price elasticity of
and the cross-price elasticity of demand refers to
supply, then a change in price will have only a small
shifts in the demand curve caused by changes in
impact on the quantity supplied.
the price of other goods. Most goods are normal
KEY TERMS
price control
price ceiling
price floor
rent control
minimum wage
price elasticity of demand perfectly elastic demand
unit-free measure
income elasticity of
elastic demand
demand
inelastic demand
cross-price elasticity of
perfectly inelastic demand
demand
price elasticity of supply
perfectly elastic supply
perfectly inelastic supply
QUESTIONS FOR REVIEW
1. Why is the price elasticity of demand a unit-free
6. Why is the price elasticity of demand lower in the
measure of the sensitivity of the quantity demanded
short run than in the long run?
to a price change?
7. For what values of the price elasticity of demand do
2. What factors determine whether the price elasticity
increases in the price increase revenue?
of demand is high or low?
8. What is the income elasticity of demand?
3. What is the difference between elastic and inelastic 9. What is the difference between the price elasticity
demand?
of demand and the income elasticity of demand?
4. Why is the price elasticity of demand useful fur
10. What is the slope of a perfectly elastic supply curve?
finding the size of the price change that occurs when
supply shifts?
5. If the price elasticity of demand for textbooks is 2
and the price of textbooks increases by 10 percent, by
how much does the quantity demanded fall?
PROBLEMS
1. Consider the market for automatic teller machinehappens to quantity supplied and quantitv
services in a city. The price is the fee for a cash
demanded?
withdrawal.
d. Economists frequently argue against price
a. Sketch the demand curve and the supply curve for
controls because of the shortages and associated
ATM transactions.
problems that they create. What are some of the
b. I low is the equilibrium price determined?
potentially negative side effects of interference in
c. If the town council imposes a ban on ATM fees—
the ATM market?
equivalent to a price ceiling in this market—what
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CHAPTER 4 Subtleties of the Supply and Demand Model: Price Floors, Price Ceilings, and Elasticity
6. Consider the follow ing data for a supply curve:
2. In 1991 the price of milk fell 30 percent. Senator
Leahy of Vermont, a big milk-producing state,
Price
Quantity Supplied
supported a law in the U.S. Congress to put a floor on
2
10
the price. The floor was SI3.09 per hundred pounds
3
20
of milk. The market price was $11.47.
4
30
a. Draw a supply and demand diagram for milk
5
40
6
50
and show how the equilibrium price and quantity
7
1,0
would he determined in the absence of the
8
70
9
80
price floor.
b. Using the diagram you just drew, explain the
a. Use the midpoint formula to calculate the
effects of the legislation.
price elasticity of supply between a price of S7
c. The dairy farmers supported the legislation, while
and $8.
consumer groups opposed it. Why?
b. Use the midpoint formula to calculate the
d. Economists frequently argue against price floors
price elasticity of supply between a price of S3
because of the surpluses and associated problems
and
$4.
that they create. What are some of the potentially
c. How does supply elasticity change as you move up
negative side effects of interference in the milk
the supply curve?
market?
d. Why does the supply elasticity change even
3. More than twenty states have laws outlawing price
though the slope of the supply curve is unchanged
gouging during a state of emergency, w hich might be
as you move up the supply curve?
declared after a hurricane or an earthquake. These
7. Given the following income elasticities of demand.
laws prohibit price increases on basic necessities,
would you classify- the following goods as normal or
such as gasoline. Which of the arguments against
inferior goods?
price ceilings might not be very significant during a
a. Potatoes: elasticity = 0.5
state of emergency?
b. Pinto beans: elasticity = -0.1
4. Donors of organs for transplantation or medical
c. Bottled water: elasticity = 1.1
research are prohibited from charging a price for
d.
Video cameras: elasticity = 1.4
Price
Quantity
these organs (there is a price ceiling of zero). Will this
11
10 market cope with 8. Calculate the cross-price elasticity for the following
result in a shortage?
How will the
goods. Are they substitutes or complements?
20
the shortage?10
9
30a demand curve:
a. The price of movie theater tickets goes up bv 10
5. Consider the following
data
for
8
111
percent, causing the quantity demanded for video
7
50
6
60
rentals to go up by 4 percent.
5
70
b.
The
price of computers falls by 20 percent.
4
80
causing the quantity demanded of softw are to
3
90
increase by 15 percent.
c. The price of apples falls by 5 percent, causing the
a. Use the midpoint formula to calculate the
quantity demanded of pears to fall by 5 percent.
elasticitv between a price of S10 and SI 1.
d. The price of ice cream falls by 6 percent, causing
b. Use the midpoint formula to calculate the
the quantity demanded of frozen yogurt to fall by
elasticity betw een a price of S3 and S4.
1 percent.
c. Since this is a linear demand curve, why does the
9. Food items often have low elasticities of demand.
elasticity change?
Suppose excellent weather leads to bumper yields of
d. At what point is price times quantity maximized?
agricultural crops. Why might farmers complain
What is the elasticity at that point?
about market conditions?
10. The board of directors of an airline wishes to
increase revenue. One group favors cutting airfares.
and the other group favors raising airfares. What are
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the
assumptions
group is making about the
price
elasticity ofeach
demand?
Problems
11. Compare a market in which supply and demand are
very (but not perfectly) inelastic to one in which
supply and demand are very (but not perfectly)
elastic. Suppose the government decides to impose
a price floor $1 above the equilibrium price in each
of these markets. Compare, diagrammatically, the
surpluses that result. In which market is the surplus
larger?
12. In 1992, the federal government placed a tax of 10
percent on goods like luxury automobiles and
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yachts. The yacht-manufacturing industry had
huge declines in orders for yachts and laid off
many workers, whereas the reaction in the auto
industry was much milder. (The tax on yachts was
subsequently removed.) Explain this situation
using two supply and demand diagrams. Compare
the elasticity of demand for luxury autos with
that for yachts based on the experience with the
luxury tax.
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C h a p t e r
5
T h e
D e m a n d
B e h a v i o r
T
o f
C u r v e
a n d
t h e
C o n s u m e r s
his is a true story about a college professor who loves to teach introductory
economics. The professor is younger than most college professors, but is
hard of hearing and wears hearing aids in both ears. The professor teaches
one of those large lecture courses, and most students aren't even aware that the professor wears the hearing aids.
In the middle of one of the lectures, the professor simultaneously brings one
hand to one ear and the other hand to the other ear and suddenly pulls out both
hearing aids, saying, "I can't hear a thing. If it were not for these hearing aids. I
wouldn't be here. I couldn't be a teacher. Do you know how much benefit I get from
these hearing aids? Certainly more than from my car and maybe even more than
from my house. If I had to give you a dollar amount, I would say that the benefit to
me is about $60,000. Without the hearing aids, I would probably earn less, and 1 know
my life would not be as enjoyable. Of course, 1 had to buy these hearing aids, and they
are not very cheap. They cost me $500. But, you know, they cost me a lot less than
they benefit me. The difference between $60,000 and $500 is $59,500. a huge amount.
That difference is a measure of what the hearing aid market delivers to me over and
above what I had to pay for the hearing aids. Most people would call that a good deal.
but because I am an economics professor, I call it a consumer surplus."
In this chapter we show how and why the demand curve for any good—whether
hearing aids, MP3 players, grapes, or bananas—can be used to measure the "good
deal," or the "consumer surplus." that markets deliver to people.
Figure 1 shows a typical demand curve, with price on the vertical axis and quantity demanded on the horizontal axis. The demand curve is for an entire market.
which might consist of millions of consumers. But consumers do not go to the
market with a demand curve; they go w ith certain preferences and objectives. In this
116
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