Intermediate

Microeconomics
Vivekananda Mukherjee
Department of Economics, Jadavpur University
Lecture 7 and 8
Price elasticity of supply
•  Supply function:

• Elasticity of supply
) ) always positive

• Interest elasticity of supply

) ) always negative

• Linear supply function:

 𝑆 ( 𝑝 , ∙ )= − 𝑣𝑟 + 𝑑 𝑝 ; 𝑣 > 0 , 𝑑> 0.
…… and can be calculated
𝑖 𝑖from market data. 𝑖
Summary and clarification
Market for Crushed Stone in the US in the late 2000s
 
  S2008
(US$/ton)
 slope of S2008
= 3 million tons/$

 Elasticity of S2008 at E
E* = 3.
10
E
9
 
Calculation of
30
D2009
 Equation of S2008
D2008

0 30 33 Q(million
tons/year)
 Market for Crushed Stone in the US in the late 2000s
 
  S2010 S2008
(US$/ton)  slope of D2008
= million tons/$
million tons/$

 Elasticity of D2008 at E
E’ E* = 2.
10
E
9
 
Calculation of
30
D2009
 Equation of D2008
D2008

0 28 30 33 Q(million
Exercise: Derive the equation for D2009 and S2010. tons/year)
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES
Demand
Gasoline: Short-Run and
Long-Run Demand
Curves
In the short run, an increase in
price has only a small effect on
the quantity of gasoline
demanded. Motorists may drive
less, but they will not change the
kinds of cars they are driving
overnight.

In the longer run, however,

because they will shift to smaller
and more fuel-efficient cars, the
effect of the price increase will
be larger. Demand, therefore, is
more elastic in the long run than
in the short run.
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES (Contd.)

Demand
Demand and Durability
Automobiles: Short-Run
and Long-Run Demand
Curves
The opposite is true for
automobile demand. If price
increases, consumers initially
defer buying new cars; thus
annual quantity demanded falls
sharply.

In the longer run, however, old

cars wear out and must be
replaced; thus annual quantity
demanded picks up. Demand,
therefore, is less elastic in the
long run than in the short run.
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES (Contd.)

Demand

Income Elasticities
Income elasticities also differ from the short run to the
long run.

For most goods and services—foods, beverages, fuel,

entertainment, etc.— the income elasticity of demand is
larger in the long run than in the short run.

For a durable good, the opposite is true. The short-run

income elasticity of demand will be much larger than the
long-run elasticity.
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES (Contd.)

Demand

TABLE 2.1 Demand for Gasoline

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

TABLE 2.2 Demand for Automobiles

Number of Years Allowed to Pass Following
a Price or Income Change
Elasticity 1 2 3 5 10
Price −1.2 −0.9 −0.8 −0.6 −0.4
Income 3.0 2.3 1.9 1.4 1.0
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES (Contd.)

Demand
Cyclical Industries
Consumption of
Durables versus
Nondurables
Annual growth rates are
compared for GDP, consumer
expenditures on durable goods
(automobiles, appliances,
furniture, etc.), and consumer
expenditures on nondurable
goods (food, clothing, services,
etc.).
Because the stock of durables is
large compared with annual
demand, short-run demand
elasticities are larger than long-
run elasticities. Like capital
equipment, industries that
produce consumer durables are
“cyclical” (i.e., changes in GDP
are magnified). This is not true for
producers of nondurables.
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES

Supply

Copper: Short-Run and

Long-Run Supply
Curves

If price increases, firms

would like to produce more
but are limited by capacity
constraints in the short run.

In the longer run, they can

add to capacity and
produce more.
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES

Supply
Supply and Durability
Copper: Short-Run and
Long-Run Supply
Curves
Part (b) shows supply curves
for secondary copper.
If the price increases, there is
a greater incentive to convert
scrap copper into new supply.
Initially, therefore, secondary
supply (i.e., supply from scrap)
increases sharply.
But later, as the stock of scrap
falls, secondary supply
contracts.
Table 2.3 Supply of Copper
Secondary supply is therefore
less elastic in the long run than Price Elasticity of: Short-Run Long-Run
in the short run. Primary supply 0.20 1.60
Secondary supply 0.43 0.31
Total supply 0.25 1.50
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES (Contd.)

Supply and Demand for

Coffee
(a) A freeze or drought in
Brazil causes the supply
curve to shift to the left.
In the short run, supply is
completely inelastic; only a
fixed number of coffee
beans can be harvested.
Demand is also relatively
inelastic; consumers
change their habits only
slowly.
As a result, the initial effect
of the freeze is a sharp
increase in price, from P0
to P1.
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES (Contd.)

Supply and Demand for

Coffee
(b) In the intermediate run,
supply and demand are
both more elastic; thus
price falls part of the way
back, to P2.
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES (contd.)

Figure 2.18

Supply and Demand for Coffee

(c) In the long run, supply

is extremely elastic;
because new coffee trees
will have had time to
mature, the effect of the
freeze will have
disappeared. Price returns
to P0.
 SHORT-RUN VERSUS LONG-RUN ELASTICITIES (Contd.)

Price of Brazilian
Coffee

When droughts or
freezes damage
Brazil’s coffee trees,
the price of coffee
can soar.
The price usually falls
again after a few
years, as demand
and supply adjust.
 UNDERSTANDING AND PREDICTING THE
EFFECTS OF CHANGING MARKET CONDITIONS

Figure 2.19
Fitting Linear Supply and Demand
Curves to Data
Linear supply and demand
curves provide a convenient
tool for analysis.
Given data for the equilibrium
price and quantity P* and Q*,
as well as estimates of the
elasticities of demand and
supply ED and ES, we can
calculate the parameters c and
d for the supply curve and a
and b for the demand curve.
(In the case drawn here, c < 0.)
The curves can then be used
to analyze the behavior of the
market quantitatively.
UNDERSTANDING AND PREDICTING THE
EFFECTS OF CHANGING MARKET CONDITIONS (contd.)

Demand: Q = a − bP (2.5a)

Supply: Q = c + dP (2.5b)

• Step 1:

E = (P/Q)(ΔQ/ΔP)

Demand: ED = −b(P*/Q*) (2.6a)

Supply: ES = d(P*/Q*) (2.6b)

• Step 2:

a = Q* + bP*
  𝑐 =𝑄 ∗ − 𝑑 𝑃∗ (2.7)