2.

ELASTICITIES OF SUPPLY AND DEMAND

Elasticities of Supply
price elasticity of supply Percentage change in quantity supplied resulting from a 1-percent increase in price.

2.4

For a few decades, changes in the wheat market had major implications for both American farmers and U.S. agricultural policy. To understand what happened, lets examine the behavior of supply and demand beginning in 1981.

By setting the quantity supplied equal to the quantity demanded, we can determine the market-clearing price of wheat for 1981:

2.4

Substituting into the supply curve equation, we get

2.5

SHORT-RUN VERSUS LONG-RUN ELASTICITIES

We use the demand curve to find the price elasticity of demand:

TABLE 2.1

Demand for Gasoline

Number of Years Allowed to Pass Following a Price or Income Change 1 2 3 5 10 0.2 0.3 0.4 0.5 0.8 0.2 0.4 0.5 0.6 1.0

Thus demand is inelastic. We can likewise calculate the price elasticity of supply:

Elasticity Price Income

TABLE 2.2

Demand for Automobiles

Number of Years Allowed to Pass Following a Price or Income Change 1 2 3 5 10 1.2 0.9 0.8 0.6 0.4 3.0 2.3 1.9 1.4 1.0

Because these supply and demand curves are linear, the price elasticities will vary as we move along the curves.

Elasticity Price Income

2.6

UNDERSTANDING AND PREDICTING THE EFFECTS OF CHANGING MARKET CONDITIONS

2.7
Figure 2.25 Price of Natural Gas

2.7
Supply of gas: Demand for gas: Q = 15.90 + 0.72PG + 0.05PO Q = -10.35 - 0.18PG + 0.69PO

Given PO=$50 In free market, the equilibrium is PG*=$6.4 and Q*=23 Tcf

Supply of gas: Demand for gas:

Q = 15.90 + 0.72(3) + 0.05(50)=20.6 Q = -10.35 - 0.18(3) + 0.69(50)=29.1

Price control on Natural Gas at $3.00 Shortage or excess demand is D-S=29.1-20.6=8.5 Tcf

1. From 1970 to 1993 1993, , the real price of a college education increased, and total enrollment increased. Which of the following could have caused this increase in price and enrollment? enrollment?
a) A shift to the right in the supply curve for college education and a shift to the left in the demand curve for college education. b) A shift to the left in the supply curve for college education and a shift to the left in the demand curve for college education. c) A shift to the left in the supply curve for college education and a shift to the right in the demand curve for college education. d) none of the above

Multiple Choice Questions

2. The effect of the September 11 attacks on the World Trade Center on the market for office space in downtown Manhattan was that both the equilibrium price and the equilibrium quantity fell. What is the most likely explanation for this? a) Supply and demand both shifted left, and the magnitude of the demand shift was greater. b) Supply shifted left, demand shifted right, and the magnitude of the supply shift was greater. c) Supply shifted left, demand shifted right, and the magnitude of the demand shift was greater. d) Supply and demand both shifted left, and the magnitude of the supply shift was greater.

3. Last year, the world demand curve for copper shifted rightward due to continued economic growth in China and other emerging economies. Also, the supply curve for copper shifted leftward due to strikes and other labor disruptions at some of the copper mines. As a result, we observed: a) higher equilibrium copper prices and either higher or lower quantities. b) higher equilibrium copper prices and unambiguously lower quantities. c) higher equilibrium copper prices and unambiguously higher quantities. d) lower equilibrium copper prices and either higher or lower quantities.

4. The cross price elasticity between a pair of complementary goods will be

a) b) c) d) negative. positive. zero. positive or zero depending upon the strength of the relationship.

5. Refer to the Figure. At point A, demand is:

a) elastic, but not infinitely elastic. b) inelastic, but not completely inelastic. c) infinitely elastic. d) unit elastic.

6. Use the following statements to answer this question: I. Even though people need water to survive, the price of water is less than the price of diamonds because water is in greater supply than diamonds. II. Suppose that the demand for corn is highly price inelastic. If every corn farmer's harvesting technologies become more efficient, the total revenue received by all corn farmers would fall. a) b) c) d) I and II are false. I is true, and II is false. II is true, and I is false. I and II are true.

7. Which of the following results from a binding price floor? floor?

a) b) c) d) Equilibrium Shortage Excess supply Excess demand

EXERCISES
1. Suppose the demand curve for a product is given by Q = 300 2P + 4I, where I is average income measured in thousands of dollars. The supply curve is Q = 3P 50. a) If I = 25, find the market clearing price and quantity for the product. b) If I = 50, find the market clearing price and quantity for the product. c) Draw a graph to illustrate your answers.
Price (Dollars) 60 80 100 120

EXERCISES
2. Consider a competitive market for which the quantities demanded and supplied (per year) at various prices are given as follows:
Supply (Millions) 14 16 18 20

Demand (Millions) 22 20 18 16

a) b) c) d)

Calculate the price elasticity of demand when the price is $80 and when the price is $100. Calculate the price elasticity of supply when the price is $80 and when the price is $100. What are the equilibrium price and quantity? Suppose the government sets a price ceiling of $80. Will there be a shortage, and if so, how large will it be?