Price Elasticity of Supply and Demand

Demand: a measure of how responsive quantity demanded is to a change in price.

Supply: a measure of how responsive quantity supplied is to a change in price.

If something is relatively inelastic, than there is no change. If something is relatively elastic, then there is a change.

Factors influencing price elasticty of demand (PED):

• whether a good is luxury (elastic) or a necessity (inelastic)

• existence of a close substitute (closely substituted goods are more elastic)

• whether the good is habit forming (inelastic) or not (elastic)

• length of time since price increase (longer the length of time = more elastic)

• proportion of Y (income) spent on a good

Perfectly Elastic Demand:

At any price above P1 (price at D), demand is zero. any price below, demand is infinite.

EX: Market with identical products and many sellers→ no seller that is selling above P1 will sell any products and the price will then be lowered to sell.

Calculatin PED using the total outlay method:

D is elastic when revenue moves in the opposite direction to the price change.

D is inelastic when total revenue move in the same direction as the price change.

D is unit elastic if there is no change in total revenue.

Perfectly Inelastic Demand:

Change in price (total) will not changge the quantity demanded, there is no relationship between price and demand.

EX: life-saving medicine.

Factors influencing price elasticity of supply (PES):

• length of time since price increase

• ability to hold and store stock

• excess production capacity

Perfectly elastic supply:

• Suppliers will supply any amount above P0.

• At P0, the market supply = Qd.

• Suppliers will not supply a product for less than P0.

Perfeclty Inelastic supply:

• At Q0, the amount supplied is fixed and there is no relationship to a change in price.

• E: rare items, one-of-a-kind artworks (fixed supply)

*Note: aggregate supply is inelastic with no relaitonsip in the long run.