ELASTICITY OF SUPPLY
APPLICATIONS
Today’s Class…
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Definition and Calculation
Types of Supply Curves
Determinants
Applications of Elasticity in Economics
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Price Elasticity
• The price elasticity of supply is the
proportional change in quantity supplied
relative to the proportional change in price.
Percentage change in quantity supplied
ES =
Percentage change in price
Price Elasticity of Supply
• Percentage change in quantity of a good
supplied, caused by a 1% change in the price of
the good
%QS
ES 
% P
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Price Elasticity of Supply
and Shape of Supply Curve
• The price elasticity of supply is either zero or a
positive number.
• A zero price elasticity of supply means that the
quantity supplied will not vary as the price
varies.
• A positive price elasticity of supply means that
as the price of an item rises, the quantity
supplied rises.
Types of Supply curves
• Elastic supply occurs when a percentage
change in quantity supplied is greater than a
percentage change in price. 𝐸𝑠 >1
• Inelastic supply occurs when a percentage
change in quantity supplied is less than a
percentage change in price. 𝐸𝑠 < 1
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Types of Supply Curves Cont.
• Perfectly Inelastic occurs when a change in
price results in no change in quantity supplied.
𝐸𝑠 =0.
• The quantity supplied is fixed regardless of the
price level. Example: Ancient paintings
(Picasso), the number of seats at a concert
hall, the number of plots at an ocean front.
Etc.
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• Perfectly Elastic supply occurs when a change
in price results in an infinite change in
quantity supplied. 𝐸𝑠 → ∞
• A supply curve that is a ray from the origin is a
unit elastic supply curve. The supply elasticity
is 1 on any point on the supply curve.
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• For any usual upward sloping supply curve
which does not pass through the origin, the
elasticity of supply declines as quantity
increases.
The elasticity of
supply declines as
we move up the
supply curve.
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Determinants of Elasticity of Supply
• Product type: This impacts how quickly a producer is able
to respond to changes in price.
– Manufacturing firm may be able to adjust production
levels in respond to price changes with minor
adjustments in equipment.
– Agricultural products such as cocoa/coffee may
require several months to grow.
– Child care services require relatively low skills
compared to a physician and therefore the elasticity
of supply of child care services is relatively more
elastic than that of physicians.
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Determinants of Elasticity Cont.
• Production Capacity: If a firm is operating at
full capacity, then increase in supply would
require additional facilities and purchasing of
new equipment.
• A firm operating below full capacity can
respond to changes in prices quicker than a
firm that is operating at full capacity.
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• Input substitution: supply would respond more
quickly to price if the inputs that are used in the
production of another good and easily be switched
over to producing the good with the higher price.
• Examples??
• Storage possibilities: items that have a short shelf life
are more likely to be have inelastic supply compared
to products with a relatively longer shelf life.
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• The shape of the supply curve depends primarily on
the length of time being considered.
– In the short run, at least one of the resources used
in production cannot be changed.
– Hence supply is more inelastic in the short run.
– In the long run, the firm has long enough to change
any aspect of production, and therefore can more
fully respond.
– Long run supply is therefore more elastic
Interaction of Elasticities
• Both the price elasticity of demand and the price
elasticity of supply determine the full effect of a price
change.
• If the price elasticity of supply of an item is large and the
demand for it is price inelastic, then the firm can raise
the price without losing revenue.
• Conversely, if the price elasticity of supply is small and
the price elasticity of demand is large, then the firm is
unable to raise the price because the consumer will
switch to another product
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Applications of Elasticity Concept
• The ‘war on drugs’ by many governments in many countries
has been unsuccessful mainly because these governments
have focused on supply reduction. To win this war, some
economists believe that governments will have to concentrate
on reducing demand through drug education programs etc.
• Do you agree? Why or Why not?
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• Suppose the price elasticity of demand for cocaine is
-0.5. What will happen to the equilibrium price,
quantity and total expenditures on cocaine if the
government succeeds in
its efforts to reduce demand?
• What is likely to happen to the incentive to traffic
cocaine?
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 The price elasticity of demand for
cocaine is -0.5  demand is
relatively inelastic
 Suppose government succeeds in
reducing demand  equilibrium
price ↓ and equilibrium quantity ↓.
 What happens to total expenditure
on cocaine? If price↓, total
expenditure ↓ because demand is
price inelastic.
 What happens to incentive to traffic
cocaine? ↓ Reduced revenues is
likely to deter drug trafficking.
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Option 2
• Suppose the government continues to concentrate its efforts
on supply reduction and is able to reduce the supply of
cocaine.
• As a result of the reduction in supply the price of cocaine
increases by 25 percent.
• If the price elasticity of demand is -0.5, what is likely to
happen to the incentive to traffic cocaine?
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 Suppose government succeeds in
reducing supply  equilibrium
price ↑ and equilibrium quantity
↓.
 What happens to total
expenditure on cocaine? If
price↑, total expenditure ↑
because demand is price
inelastic.
 What happens to incentive to
traffic cocaine? ↑ Increased
revenues raises the incentive to
traffic cocaine.
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Application: How the burden of tax is
determined
 If the price elasticity of demand (in absolute terms) is higher
than the price elasticity of supply, then buyers are more
willing to do without the product and will avoid most of the
tax. Thus, the consumers’ burden of the tax is less than the
producers’ burden.
 If the price elasticity of supply is higher than the price
elasticity of demand elasticity (in absolute terms), then,
sellers are more responsive to price changes and can avoid
most of the tax. Thus, the consumers’ burden is greater than
the producers’ burden.
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Example 1
• Consider the cigarette market. Suppose at “e”, the absolute
value of the price elasticity of demand is 0.7 and the price
elasticity of supply is 1.1. Now a per-unit tax is imposed on
every unit sold. How is the tax burden shared?
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• Since the price elasticity of supply > price elasticity of demand (in
absolute value), the consumer’s burden is greater than the
producer’s burden.
• Verify: Shift the supply curve upwards by the full amount of the
tax. The vertical distance jk represents the amount of the tax.
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Example 2
• Consider a market in which supply is perfectly elastic and the
demand curve is the usual downward-sloping curve. If a $0.20
unit tax is imposed in this market, how is the tax burden
shared?
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• At point f the price elasticity of supply is infinity and the
absolute value of the price elasticity of demand is less than
infinity. In this case, consumers bear the entire burden of the
tax.
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Next Class…
• Consumer Choice Theory
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