978-1285165905 Chapter 5 Part 2

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94 ❖ Chapter 5/Elasticity and Its Application

the percentage change in quantity supplied divided by the percentage change in

price.

2. Determinants of the Price Elasticity of Supply

a. Flexibility of sellers: goods that are somewhat fixed in supply (beachfront property) have

inelastic supplies.

b. Time horizon: supply is usually more inelastic in the short run than in the long run.

B. Computing the Price Elasticity of Supply

1. Formula

2. Example: the price of milk increases from $2.85 per gallon to $3.15 per gallon and the

quantity supplied rises from 9,000 to 11,000 gallons per month.

% change in price = (3.15 – 2.85)/3.00 × 100 = 10%

% change in quantity supplied = (11,000 – 9,000)/10,000 × 100 = 20%

Price elasticity of supply = (20%)/(10%) = 2

C. The Variety of Supply Curves

1. In general, the flatter the supply curve that passes through a given point, the more elastic

the supply.

2. Extreme Cases

vertical line.

line.

3. Because firms often have a maximum capacity for production, the elasticity of supply may be

very high at low levels of quantity supplied and very low at high levels of quantity supplied.

% change in quantity supplied

Price elasticity of supply = % change in price

Figure 5

Figure 6

Again, you may want to present several examples of goods that may have supply

curves like these.

Chapter 5/Elasticity and Its Application ❖ 95

1. A new hybrid of wheat is developed that is more productive than those used in the past.

What happens?

3. If demand is inelastic, the fall in price is greater than the increase in quantity demanded and

total revenue falls.

4. If demand is elastic, the fall in price is smaller than the rise in quantity demanded and total

revenue rises.

5. In practice, the demand for basic foodstuffs (like wheat) is usually inelastic.

a. This means less revenue for farmers.

b. Because farmers are price takers, they still have the incentive to adopt the new hybrid so

that they can produce and sell more wheat.

c. This may help explain why the number of farms has declined so dramatically over the

past two centuries.

d. This may also explain why some government policies encourage farmers to decrease the

amount of crops planted.

B. Why Did OPEC Fail to Keep the Price of Oil High?

Figure 7

96 ❖ Chapter 5/Elasticity and Its Application

1. In the 1970s and 1980s, OPEC reduced the amount of oil it was willing to supply to world

markets. The decrease in supply led to an increase in the price of oil and a decrease in

quantity demanded. The increase in price was much larger in the short run than the long run.

Why?

2. The demand and supply of oil are much more inelastic in the short run than the long run.

The demand is more elastic in the long run because consumers can adjust to the higher price

more.

C. Does Drug Interdiction Increase or Decrease Drug-Related Crime?

1. The federal government increases the number of federal agents devoted to the war on

drugs. What happens?

b. Thus, because the demand for drugs is likely to be inelastic, drug-related crime may rise.

2. What happens if the government instead pursued a policy of drug education?

b. Thus, drug education should not increase drug-related crime.

Figure 8

Short Run

Long Run

Chapter 5/Elasticity and Its Application ❖ 97

SOLUTIONS TO TEXT PROBLEMS:

Quick Quizzes

When demand is inelastic (a price elasticity less than 1), a price increase raises total revenue,

and a price decrease reduces total revenue. When demand is elastic (a price elasticity

greater than 1), a price increase reduces total revenue, and a price decrease increases total

revenue. When demand is unit elastic (a price elasticity equal to 1), a change in price does

not affect total revenue.

The price elasticity of supply might be different in the long run than in the short run because

over short periods of time, firms cannot easily change the sizes of their factories to make

more or less of a good. Thus, in the short run, the quantity supplied is not very responsive

to the price. However, over longer periods, firms can build new factories, expand existing

3. A drought that destroys half of all farm crops could be good for farmers (at least those

unaffected by the drought) if the demand for the crops is inelastic. The shift to the left of

the supply curve leads to a price increase that will raise total revenue if the price elasticity of

demand is less than 1.

farmers better off.

Figure 9

(a) Drug Interdiction

(b) Drug Education

98 ❖ Chapter 5/Elasticity and Its Application

Questions for Review

1. The price elasticity of demand measures how much quantity demanded responds to a change

in price. The income elasticity of demand measures how much quantity demanded responds

to changes in consumers’ income.

horizon.

3. An elasticity greater than one means that demand is elastic. When the elasticity is greater

than one, the percentage change in quantity demanded exceeds the percentage change in

price. When the elasticity equals zero, demand is perfectly inelastic. There is no change in

4. Figure 1 presents a supply-and-demand diagram, showing the equilibrium price, P, the

equilibrium quantity, Q, and the total revenue received by producers. Total revenue equals

the equilibrium price times the equilibrium quantity, which is the area of the rectangle shown

in the figure.

Figure 1

6. A good with income elasticity less than zero is called an inferior good because as income

rises, the quantity demanded declines.

7. The price elasticity of supply is calculated as the percentage change in quantity supplied

responds to changes in price.

Chapter 5/Elasticity and Its Application ❖ 99

8. If a fixed quantity of a good is available and no more can be made, the price elasticity of

quantity supplied.

9. Destruction of half of the fava bean crop is more likely to hurt fava bean farmers if the

demand for fava beans is very elastic. Destruction of half of the crop causes the supply

curve to shift to the left resulting in a higher price of fava beans. When demand is very

elastic, an increase in price leads to a decrease in total revenue because the decrease in

quantity demanded outweighs the increase in price.

Quick Check Multiple Choice

1. a

2. b

3. d

4. c

5. a

6. c

Problems and Applications

1. a. Mystery novels have more elastic demand than required textbooks because mystery

novels have close substitutes and are a luxury good, while required textbooks are a

necessity with no close substitutes. If the price of mystery novels were to rise, readers

could substitute other types of novels, or buy fewer novels altogether. But if the price of

required textbooks were to rise, students would have little choice but to pay the higher

price. Thus, the quantity demanded of required textbooks is less responsive to price than

the quantity demanded of mystery novels.

b. Beethoven recordings have more elastic demand than classical music recordings in

general. Beethoven recordings are a narrower market than classical music recordings, so

it is easier to find close substitutes for them. If the price of Beethoven recordings were to

rise, people could substitute other classical recordings, like Mozart. But if the price of all

classical recordings were to rise, substitution would be more difficult. (A transition from

classical music to rap is unlikely!) Thus, the quantity demanded of classical recordings is

less responsive to price than the quantity demanded of Beethoven recordings.

c. Subway rides during the next five years have more elastic demand than subway rides

during the next six months. Goods have a more elastic demand over longer time

horizons. If the fare for a subway ride was to rise temporarily, consumers could not

switch to other forms of transportation without great expense or great inconvenience.

But if the fare for a subway ride was to remain high for a long time, people would

gradually switch to alternative forms of transportation. As a result, the quantity

demanded of subway rides during the next six months will be less responsive to changes

in the price than the quantity demanded of subway rides during the next five years.

d. Root beer has more elastic demand than water. Root beer is a luxury with close

substitutes, while water is a necessity with no close substitutes. If the price of water

were to rise, consumers have little choice but to pay the higher price. But if the price of

root beer were to rise, consumers could easily switch to other sodas or beverages. So the

demanded of water.

100 ❖ Chapter 5/Elasticity and Its Application

2. a. For business travelers, the price elasticity of demand when the price of tickets rises from

$200 to $250 is [(2,000 – 1,900)/1,950]/[(250 – 200)/225] = 0.05/0.22 = 0.23. For

$250 is [(800 – 600)/700] / [(250 – 200)/225] = 0.29/0.22 = 1.32.

b. The price elasticity of demand for vacationers is higher than the elasticity for business

travelers because vacationers can choose a substitute more easily than business

travelers. For example, vacationers can choose a different mode of transportation (like

3. a. The percentage change in price is equal to (2.20 – 1.80)/2.00 x 100 = 20%. If the price

elasticity of demand is 0.2, quantity demanded will fall by 4% in the short run

[0.20  0.20]. If the price elasticity of demand is 0.7, quantity demanded will fall by 14%

in the long run [0.7  0.2].

4. If quantity demanded fell, price must have increased according to the law of demand. For a

price increase to increase total revenue, the percentage increase in the price must be

greater than the percentage decline in quantity demanded. Therefore, demand is inelastic.

increases, and the quantity decreases.

quantity decreases.

Because cups of coffee have an inelastic demand, when the price of a cup of coffee

increases, the total expenditure on coffee increases.

Quantity

Price

Figure 2

Demand

Chapter 5/Elasticity and Its Application ❖ 101

donuts because coffee and donuts are complements. When demand decreases, the price

of donuts decreases.

Because donuts have an inelastic demand, when the price of donuts decreases, the total

expenditure on donuts decreases.

elasticity is [(50 – 45)/47.5]/[(10 – 8)/9] = 0.11/0.22 = 0.5.

b. If the price is $12, your income elasticity of demand as your income increases from

$10,000 to $12,000 is [(30 – 24)/27]/[(12,000 – 10,000)/11,000] = 0.22/0.18 = 1.22. If

the price is $16, your income elasticity of demand as your income increases from

$10,000 to $12,000 is [(12 – 8)/10]/[(12,000 – 10,000)/11,000] = 0.40/0.18 = 2.22.

equal her percentage change in income.

b. Maria’s price elasticity of clothing demand is also one, because every percentage point

increase in the price of clothing would lead her to reduce her quantity purchased by the

same percentage.

8. a. The percentage change in price (using the midpoint formula) is (1.50 – 1.25)/(1.375) ×

100% = 18.18%. Therefore, the price elasticity of demand is 4.3/18.18 = 0.24, which is

very elastic.

rises.

c. The elasticity estimate might be unreliable because it is only the first month after the

fare increase. As time goes by, people may switch to other means of transportation in

Price

Figure 3

Supply

102 ❖ Chapter 5/Elasticity and Its Application

response to the price increase. So the elasticity may be larger in the long run than it is in

the short run.

9. Walt’s price elasticity of demand is zero, because he wants the same quantity regardless of

the price. Jessie‘s price elasticity of demand is one, because he spends the same amount on

gas, no matter what the price, which means his percentage change in quantity is equal to the

percentage change in price.

midpoint method (note that ($3.33 – $2)/$2.67 = .50).

b. The policy will have a larger effect five years from now than it does one year from now.

The elasticity is larger in the long run, because it may take some time for people to

reduce their cigarette usage. The habit of smoking is hard to break in the short run.

higher price.

11. To determine whether you should increase or decrease the price of admissions, you need to

know if the demand is elastic or inelastic. If demand is elastic, a decline in the price of

admissions will increase total revenue. If demand is inelastic, an increase in the price of

admissions will cause total revenue to rise.

declines, thus reducing their income.