MANAGERIAL ECONOMICS.

B. Topics

PRE-LIM

1. Introduction: The Fundamentals of Managerial Economics

2. Market Forces: Demand and Supply
3. Demand and Elasticities

MID TERM

4. Production and Costs

5. Firms vs Markets
6. Managing in Competitive and Monopolistic Markets
7. Managing in Oligopolistic Markets

PRE FINALS

8. Strategic Interactions and Game Theory

9. Pricing with Market Power

FINALS

10. Incentives, Information and Market Structure

11. Regulation and Public Policy.

FINANCIAL MARKET-

Course Outline • Financial Instruments and Markets • Time Value of Money • Portfolio Selection •
Equilibrium Asset Pricing: The Capital Asset Pricing Model • Equity Valuation • Arbitrage • Fixed Income
Securities • Derivative Securities • Market Efficiency, Frictions, and Anomalies
Law of Supply and Demand
REVIEWED BY JIM CHAPPELOW

Updated Jun 13, 2019

What Is the Law of Supply and Demand?
The law of supply and demand is a theory that explains the interaction between the sellers of a
resource and the buyers for that resource. The theory defines how the relationship between the
availability of a particular product and the desire (or demand) for that product has on its price.
Generally, low supply and high demand increase price and vice versa.

KEY TAKEAWAYS

 The law of demand says that at higher prices, buyers will demand less of an economic
good.
 The law of supply says that at higher prices, sellers will supply more of an economic
good.
 These two laws interact to determine the actual market prices and volume of goods that
are traded on a market.
 Several independent factors can affect the shape of market supply and demand,
influencing both the prices and quantities that we observe in markets.
Volume 75%

1:27

Law of Supply and Demand

Understanding the Law of Supply and Demand

The law of supply and demand, one of the most basic economic laws, ties into almost all
economic principles in some way. In practice, supply and demand pull against each other until
the market finds an equilibrium price. However, multiple factors can affect both supply and
demand, causing them to increase or decrease in various ways.

Law of Demand vs. Law of Supply

The law of demand states that, if all other factors remain equal, the higher the price of a good,
the less people will demand that good. In other words, the higher the price, the lower the quantity
demanded. The amount of a good that buyers purchase at a higher price is less because as the
price of a good goes up, so does the opportunity cost of buying that good. As a result, people will
naturally avoid buying a product that will force them to forgo the consumption of something else
they value more. The chart below shows that the curve is a downward slope.

Like the law of demand, the law of supply demonstrates the quantities that will be sold at a
certain price. But unlike the law of demand, the supply relationship shows an upward slope. This
means that the higher the price, the higher the quantity supplied. Producers supply more at a
higher price because selling a higher quantity at a higher price increases revenue.
Unlike the demand relationship, however, the supply relationship is a factor of time. Time is
important to supply because suppliers must, but cannot always, react quickly to a change in
demand or price. So it is important to try and determine whether a price change that is caused by
demand will be temporary or permanent.

Let's say there's a sudden increase in the demand and price for umbrellas in an unexpected rainy
season; suppliers may simply accommodate demand by using their production equipment more
intensively. If, however, there is a climate change, and the population will need umbrellas year-
round, the change in demand and price will be expected to be long term; suppliers will have to
change their equipment and production facilities in order to meet the long-term levels of demand.

Shifts vs. Movement

For economics, the "movements" and "shifts" in relation to the supply and demand curves
represent very different market phenomena.

A movement refers to a change along a curve. On the demand curve, a movement denotes a
change in both price and quantity demanded from one point to another on the curve. The
movement implies that the demand relationship remains consistent. Therefore, a movement
along the demand curve will occur when the price of the good changes and the quantity
demanded changes in accordance to the original demand relationship. In other words, a
movement occurs when a change in the quantity demanded is caused only by a change in price,
and vice versa.

Like a movement along the demand curve, a movement along the supply curve means that the
supply relationship remains consistent. Therefore, a movement along the supply curve will occur
when the price of the good changes and the quantity supplied changes in accordance to the
original supply relationship. In other words, a movement occurs when a change in quantity
supplied is caused only by a change in price, and vice versa.

Meanwhile, a shift in a demand or supply curve occurs when a good's quantity demanded or
supplied changes even though price remains the same. For instance, if the price for a bottle of
beer was $2 and the quantity of beer demanded increased from Q1 to Q2, then there would be a
shift in the demand for beer. Shifts in the demand curve imply that the original demand
relationship has changed, meaning that quantity demand is affected by a factor other than price.
A shift in the demand relationship would occur if, for instance, beer suddenly became the only
type of alcohol available for consumption.

Conversely, if the price for a bottle of beer was $2 and the quantity supplied decreased from Q1
to Q2, then there would be a shift in the supply of beer. Like a shift in the demand curve, a shift
in the supply curve implies that the original supply curve has changed, meaning that the quantity
supplied is effected by a factor other than price. A shift in the supply curve would occur if, for
instance, a natural disaster caused a mass shortage of hops; beer manufacturers would be forced
to supply less beer for the same price.

How Do Supply and Demand Create an Equilibrium Price?

Also called a market-clearing price, the equilibriumprice is the price at which the producer can
sell all the units he wants to produce and the buyer can buy all the units he wants.

At any given point in time, the supply of a good brought to market is fixed. In other words the
supply curve in this case is a vertical line, while the demand curve is always downward sloping
due to the law of diminishing marginal utility. Sellers can charge no more than the market will
bear based on consumer demand at that point in time. Over time however, suppliers can increase
or decrease the quantity they supply to the market based on the price they expect to be able to
charge. So over time the supply curve slopes upward; the more suppliers expect to be able to
charge, the more they will be willing to produce and bring to market.

With an upward sloping supply curve and a downward sloping demand curve it is easy to
visualize that at some point the two will intersect. At this point, the market price is sufficient to
induce suppliers to bring to market that same quantity of goods that consumers will be willing to
pay for at that price. Supply and demand are balanced, or in equilibrium. The precise price and
quantity where this occurs depends on the shape and position of the respective supply and
demand curves, each of which can be influenced by a number of factors.

Factors Affecting Supply

Production capacity, production costs such as labor and materials, and the number of competitors
directly affect how much supply businesses can create. Ancillary factors such as material
availability, weather, and the reliability of supply chains also can affect supply.

Factors Affecting Demand

The number of available substitutes, consumer preferences, and the shifts in the price of
complementary products affect demand. For example, if the price of video game consoles drops,
the demand for games for that console may increase as more people buy the console and want
games for it.

Related Terms

Quantity Supplied
The quantity supplied is a term used in economics to describe the amount of
goods or services that are supplied at a given market price.
more
Law of Demand Definition
The law of demand states that quantity purchased varies inversely with price. In
other words, the higher the price, the lower the quantity demanded.
more
Equilibrium Quantity
Equilibrium quantity represents the amount of an item that is demanded at the
point of economic equilibrium, where supply and demand intersect.
more
Quantity Demanded
Quantity demanded is used in economics to describe the total amount of goods
or services that are demanded at any given point in time.
more
What is a Supply Curve?
A supply curve is a representation of the relationship between the price of a good
or service and the quantity supplied for a given period of time.
more
Demand Definition
Demand is an economic principle that describes consumer willingness to pay a
price for a good or service.
more
Elasticity of Demand and Supply # 1. Subject Matter:
Demand and Supply Theory is essential for an understanding of
economics.
It has been argued that certain relationships exist between price and
quantity demanded and supplied, other things remaining constant.
ADVERTISEMENTS:

But if price changes, by how much does quantity demanded or

supplied change? It could be that a large price increase/decrease will
have little effect of quantity demanded or supplied.
On the other hand, a small price increase/decrease might result in a
substantial change in demand or supply. Theoretically it is impossible
to say exactly what will happen in cases like these. Each product may
have a different price-quantity reaction. It is a matter for economists
to collect evidence and calculate this relationship.
However, theoretical economists can provide a useful guidance for
studying this relationship. Elasticity is a measure of the relationship
between quantity demanded or supplied and another variable, such as
price or income, which affects the quantity demanded or supplied.
Elasticity of Demand and Supply # 2. Meaning of Price
Elasticity of Demand:
Price Elasticity of demand measures the degree of responsiveness of
the quantity demanded of a commodity to change in its price. Thus its
measure depends upon comparing the percentage change in the price
with the resultant percentage change in the quantity demanded.
ADVERTISEMENTS:

Exact formulations are as follows:

There is a slight problem with computation of percentage changes in

this manner. We get different answers depending on whether we move
up or down the demand curve. One way out of this difficulty is to take
the average of two prices and the two quantities over the range we are
considering and comparing the change of the average, instead of
comparing it to the price or quantity at the start of the change.

The formula for calculating price elasticity of demand then

becomes:

ADVERTI

SEMENT

S:

Elasticity of Demand and Supply # 3. Different Kinds

of Price Elasticities:
ADVERTISEMENTS:

We have different ranges of price elasticities, depending on whether a

1% change in price elicits more or less than a 1% change in quantity
demanded.

a. Price-Elastic Demand:
If the price elasticity of demand is greater than one, we call this a
price-elastic demand. A 1% change in price causes a response greater
than 1% change in quantity demanded: ΔP < ΔQ.

b. Unitary Price Elasticity of Demand:

In this case, a 1% change in price causes a response of exactly 1%
change in the quantity demanded.

ADVERTISEMENTS:

When Area A = Area B, Rectangular Hyperbola! ΔP = AQ.

c. Price-Inelastic Demand:
Hence, a 1% change in price causes a response of less than 1% change
in quantity demanded: ΔP > ΔQ.

Elasticity of Demand and Supply # 4. Elasticity and

Slope:
Elasticity and Slope are not the same. We will demonstrate that along
a linear demand curve (that is, a straight line with a constant slope)
elasticity falls with price. As a matter of fact, the elasticity along a
downward-sloping Straight line demand curve goes numerically from
infinity to zero as we move down the curve.

ADVERTISEMENTS:

We must, therefore, specify the price range when discussing price

elasticity of demand, since most goods have ranges of both elasticity
and inelasticity. The only time we can be sure of the elasticity of a
straight line demand curve by looking at it is if it is either perfectly
horizontal or perfectly vertical. The horizontal straight line demand
curve has infinite elasticity at every quantity as given in Fig. 3.4(a).

The vertical demand curve has zero elasticity at every price

as given in Fig. 3.4(b):
Extreme Elasticities:
In Fig. 3.4(a), we show complete responsiveness. At a price of 20p,
consumers will demand an unlimited quantity of the commodity in
question. In Fig. 3.4(b), we show complete price unresponsiveness.
The demand curve is vertical at the quantity Q1 unit. That means the
price elasticity of demand is zero here. Consumers demand Q1 units of
this particular commodity — no matter what the price is.
Elasticity of Demand and Supply # 5. Elasticity and
Total Revenue/Total Expenditure:
It is generally thought that the way to increase total receipts or total
expenditure is to increase price per unit. But is this always the case? Is
it possible that a rise in price per unit could lead to a decrease in total
revenue? The real answers to these questions depend on the price
elasticity of demand.

In Table 3.1, we show in column 1 price of petrol in pounds, in column

(2) units demanded (per time period), in column (3) total revenues (P
x Q) and in column (4) values of elasticity. Notice what happens to
total revenue throughout the schedule.

They rise steadily as the price rises from £1 to £5 per unit; then, when
the price rises further to £6 per unit, total revenue remains constant at
£30. At prices higher than £6, total revenue actually falls as price is
increased. So it is not safe to assume that a price increase is always the
way to greater revenues.
Indeed, if prices are above £6 per unit in our example, total revenue
can only be increased by cutting prices.

Here, in Table 3.1, we show the elastic, unit elastic and inelastic
sections of the demand schedule according to whether a reduction in
price increases total revenue, causes them to remain constant, or
causes them to decrease. In Fig. 3.5, we show graphically what
happens to total revenue in elastic, unit-elastic and inelastic part of the
demand curve.
Hence, we have three relationships among the three types of
price elasticity and total revenue:
a. Price-Elastic Demand:
A negative relationship exists between small changes in price and
changes in total revenue. That is, if price is lowered, total revenue will
rise when the firm faces price-elastic demand. And, if it raises price,
total revenue will fall.

b. Unit Price-Elastic Demand:

Small changes in price do not change total revenue. In other words,
when the firm is facing demand that is unit-elastic, if it increases price,
total revenue will not change; if it decreases price, total revenue will
not change either.

c. Price-Inelastic Demand:
A positive relationship between small changes in price and total
revenue. That is, when the firm is facing demand that is price-
inelastic, if it raises price, total revenue will go up; if it reduces price,
total revenue will fall. We can see in Fig. 3.5 the areas in the demand
curve that are elastic, unit-elastic and inelastic. For price rise from £1
to £5 per unit, total revenue rises from £10 to £30, as demand is price-
inelastic.

When price changes from £5 to £6, however, total revenue remains

constant; at £30, demand is unit-elastic. Finally, when price rises from
£6 to £11, total revenue decreases from £30 to 0. Clearly, demand is
price-elastic. This has been shown distinctly in Fig. 3.5.

The relationship between the price elasticity of demand and total

revenue brings together some important microeconomic concepts.
Total revenue is the product of price per unit times quantity of units
sold (P x Q).

The theory of demand states that, along a given demand curve, price
and quantity changes will move in opposite directions one increases
and other decreases. Consequently, what happens to the product of
price times quantity depends on which of the opposing changes exerts
a greater force on total revenue. This is what price elasticity of demand
is designed to measure responsiveness of quantity to a change in price.

The relationship between price elasticity of demand and

total revenue is summarized:

Elasticity of Demand and Supply # 6. Determinants of

Price Elasticity:
a. Ease of Substitution:
The greater the number of substitutes available for a product, the
greater will be its elasticity of demand. For example, food as a whole
has a very inelastic demand but when we consider any particular item
of food we will find that the elasticity of demand is much greater. This
is because, while we can find no substitute for food as a whole, we can,
however, always find substitute for one type of food for another.

b. Number of Uses:
The greater the number of uses to which a commodity can be put, the
greater is its elasticity of demand. For example, electricity has many
uses — heating, lighting, cooking, etc. A rise in the price of electricity
might cause people not only to economise in all these areas but also to
substitute other fuels in some cases.

c. Proportion of Income Spent on the Product:

If the price of a packet of salt were to rise by 50%, for example from
20p to 30p, it would discourage very few people because it constitutes
a very small proportion of their income. However, if the price of a car
were to rise from £4,000 to £6,000, it would have an enormous effect
on sales, even though it would be the same percentage increase.

The greater the proportion of income which the price of the product
represents the greater its elasticity of demand will tend to be.

d. Time:
In general, elasticity of demand will tend to be greater in the long-run
than in the short-run. The period of time we are considering plays an
important role in shaping the demand curve. For example, if the price
of meat rises disproportionately to other foods, eating habits cannot be
changed immediately.

So, people will continue to demand the same amount of meat in the
short-run. But, in the long-run, people will begin to seek substitutes.
Whether or not this is a noticeable effect will depend upon whether or
not consumers discover adequate substitutes. It may also be possible
to obscure the opposite effect.

e. Durability:
The greater the durability of a product, the greater its elasticity of
demand will tend to be. For example, if the price of potatoes rises, it is
not possible to eat the same potatoes twice. However, if the price of
furniture rises, we can make our existing furniture last longer.

f. Addiction:
Where a product is habit-forming, for example, cigarettes, this will
tend to reduce its elasticity of demand.

g. The Price of Other Products:

We know that a rise in the price of a product will cause the demand for
its substitutes to rise and the demand for its complements to fall.
Thus, an increase (or decrease) of demand by a constant percentage
leaves elasticity unchanged, but a rightward shift of the curve by a
fixed amount reduces elasticity.
In both diagrams in Fig. 3.6, there has been an increase in demand
which has moved the demand curve rightwards. In diagram 3.6(a), it
can been seen that the shift of the whole curve to the right has reduced
its elasticity. In Fig. 3.6(b), however, demand has increased by a
constant percentage at every price, elasticity has remained constant.

(a) Elasticity decreases when the whole demand curve

moves out wards.
(b) Elasticity remains unchanged when demand curve
swivels.
Elasticity of Demand and Supply # 7. Value of
Elasticity:
An increase (+) in price will cause a fall (-) in quantity and, conversely
a decree (-) in the value of the answer must always be negative. The
coefficient is expressed as S by putting a minus sign in front of the
equation, thus: ED = –
Elasticity of Demand and Supply # 8. Arc Elasticity:
It is an estimate of elasticity along a range of a demand curve.

It can be calculated for both linear and non-linear demand

curves using the following formula:
Arc elasticity of demand:

In this formula P1 and q1 represent the original price and quantity, and
P2and q2 represent the new price and quantity.
Thus, (P1 + P2)/2 is a measure of the average price in the range along
the demand curve and (q1 + q2) / 2 is the average quantity in this
range.
Elasticity of Demand and Supply # 9. Short-Run and
Long-Run:
The P elasticity of demand varies with time in which consumers can
adjust their spending patterns which prices change. The most
dramatic price change of the last 50 years — the oil price rise of 1973-
74 — caught many households with a new but fuel-inefficient car. At
first, they expected that the higher oil price may not last long.

Then they must have planned to buy a smaller car with greater fuel
use. But in countries like the US few small cars were yet available. In
the SR, households were stuck. Unless they could rearrange their
lifestyles to reduce car use, they had to pay the higher petrol prices.
Demand for petrol was inelastic.

Over a longer period, consumers had time to sell their big cars and buy
cars with better fuel economy, or to move from the distant suburbs
closer to their place of work. Over this long period, they could reduce
the quantity of petrol demanded much more than initially.

The price elasticity of demand is lower in the SR than in the LR when

there is more scope to substitute other goods. This result is very
general. Even if addicted smokers can’t adjust to arise in the price of
cigarettes, fewer young people start smoking and, gradually, the
number of smokers falls.

Demand responses to a change in the price of chocolate should be

completed within a few months, but the full adjustment to changes in
the price of oil or cigarettes may take years.
Elasticity of Demand and Supply # 10. Using Income
Elasticity of Demand
Income elasticities help us forecast the pattern of consumer demand
as the economy grows and people get richer. Suppose real incomes
grow by 15% over the next 5 years. The estimates of demand imply that
tobacco demand will fall, but the demand for substantially.

The growth prospects of these two industries are very different. These
forecasts will affect decisions by firms about whether to build new
factories and government projections of tax revenue from cigarettes of
alcohol. Similarly, as poor countries get richer, they demand more
luxuries such as televisions, washing machines, and cars.

Free Markets and Price Control:

Free markets allow prices to be determined purely by forces D & S
Government action may shift d and s curves, as when changes in safety
legislation shift the Sc, but the government makes no attempt to
regulate prices directly.

If prices are sufficiently flexible, the pressure of ED or ES will quickly

bid prices in a free market to their equilibrium level. Market will not
be free when effective price controls exist. Price controls may be floor
prices (minimum prices) or ceiling prices (maximum prices).

Price controls are government rules or laws that forbid the adjustment
of prices to clear markets. Price ceiling makes it illegal for sellers to
charge more than a specific max price. Ceiling may be introduced
when a shortage of a commodity threatens to raise its price a lot. High
prices are the way a free market ration goods in scarce supply.
This solves the allocation problem, ensuring that only a small quantity
of the scarce commodity is demanded, but it may be thought to be
unfair, a normative value judgement. High food prices mean hardship
for the poor. Faced with a national food shortage, a government may
impose a price ceiling on food so that poor people can afford it.

Free market equm is at E. The high price P0 choked off quantity

demanded to ration scarce supply. A price ceiling at P1 succeeds in
holding down the price but leads to ED AB. It also reduces QS from
Q0 to Q1. A price ceiling at P2 is irrelevant since the free market equm is
at E can still be attained.

Fig. 3.7 shows the market of food. Wars have disrupted imports of
food. The sc is far to the left of free market equn price P0 is very high.
Instead of allowing free market equn at E, the government imposes a P
ceiling P1. The quantity sold is Q1 and ED is the distance AB. The price
ceiling creates a shortage of supply relative to demand by holding food
prices below their equilibrium level.
The ceiling price P1 allows the poor to afford food, but it reduces total
food supplied from Q0 to Q1 with ED AB at the ceiling price, rationing
must be used to decide which potential buyers are actually supplied.
This rationing system could be arbitrary.
Food may go to suppliers’ friends, not necessarily the poor, or may
take bribes from the rich who jump the queue. Holding down the price
of food may not help the poor after all. Ceiling prices are often
organised by rationing by quota to ensure that available supply is
shared out fairly, independently of ability to pay.

Whereas the aim of a price ceiling is to reduce the price for consumers,
the aim of a floor price is to raise the price for suppliers. One example
of a floor price is a national minimum wage or floor price for
agricultural products.

Fig. 3.8 shows a floor price P1 for butter. In previous examples we

assumed that the quantity traded would be the smaller of QS and QD
at the controlled price since private individuals cannot be forced to
participate in a market. There is another possibility, the government
may intervene not only to set the control price but also to buy or sell
quantities of the good to supplement private purchases and sales.

At the floor price P1 private individuals demand Q1 but supply Q2. In

the absence of government sales or purchases the quantity traded will
be Q1, the smaller of Q1 + Q2.
However, the government may agree to purchase the ES AB so that
neither private suppliers nor private demanders need be frustrated.
Because European butter prices are set above the free market
equilibrium price as part of the CAP, European governments have
been forced to purchase massive stocks of butter that would otherwise
have been unsold at the controlled price. Hence the famous butter
mountain.
At floor price P1 supply is Q2, but demand Q1. Only Q1 will be traded. By
buying up the ES AB, the government can satisfy both suppliers and
consumers at the price P1.

Elasticity of Demand and Supply # 11. Income

Elasticity:
We know that the demand for a product has several determinants. So
far we have been concerned with how demand changes in response to
price changes. Another important determinant of demand is income
(Y). The response of demand to changes in income may also be
measured.

Income elasticity of demand measures the degree of responsiveness of

the quantity demanded of a product to changes in income. Income
elasticity of demand

Ey = Percentage change in quantity demanded/Percentage change in

income

This may be written as or x where Y = income

For most commodities, increase in income leads to an increase in
demand, and, therefore, income elasticity is positive. We have the
same subdivision of income elasticity as of price elasticity. Thus,
commodities may be income-elastic, income-inelastic, and unit
income elastic.

Virtually all commodities have negative price elasticities. But income

elasticity could be both positive and negative. Goods with positive
income elasticities are called normal goods. Goods with negative
income elasticities are called inferior goods; for them rise in income is
accompanied by a fall in quantity demanded. Normal goods are much
more common than inferior goods.

Elasticity of Demand and Supply # 12. Cross-Elasticity:

The responsiveness of quantity demanded of one commodity to
changes in the prices of other commodities is often of considerable
interest. This type of responsiveness is called cross- elasticity of
demand.
Cross-elasticity varies from minus infinity to plus infinity.
Complementary goods have negative cross-elasticities and substitute
goods have positive cross-elasticities.

Elasticity of Demand and Supply # 13. Elasticity of

Supply:
Much of what we have said about elasticity of demand will hold true
for elasticity of supply. Definition of elasticity of supply is very similar.

Elasticity of supply measures the degree of responsiveness of quantity

supplied to changes in price.

Thus, the elasticity of supply may be written as:

This appears to be identical with the formula for elasticity of demand.

However, you will recall that price elasticity of demand is always
negative. But price elasticity of supply is normally positive since the
supply curve slopes upwards from left to right; except in the case of a
backward-bending supply curve, in which case it would have negative
elasticity.

Elasticity of Demand and Supply # 14. Classifying

Supply Elasticities:
There are three cases of supply elasticity as in Fig. 3.9. SS is a perfectly
elastic supply curve, S’S’ is a zero elastic (or perfectly inelastic) supply
curve and OS” is a unit-elastic supply curve. Any straight line supply
curve that passes through the origin has an elasticity of unity
irrespective of steepness of the curve.

Elasticity of Demand and Supply # 15. Price Elasticity

of Supply and Length of Time for Adjustment:
We already know that the longer the time allowed for adjustment, the
greater the price elasticity of demand. The same proposition also
applies to supply.

The longer the time for adjustment, the more price-elastic

the supply curve becomes:
1. The longer the time allowed for adjustment, the more firms are able
to figure out ways to increase production in an industry.
2. The longer the time allowed, the more resources can flow into an
industry through expansion of existing firms.

We, therefore, talk about short-run and long-run price elasticities of

supply. The short-run is a time-period during which full adjustment
has not yet taken place. The long-run is the time- period during which
firms have been able to adjust fully to the change in price.

We can show a whole set of supply curves similar to the ones we did
for demand. In Fig. 3.10, when nothing can be done in the short-run,
the supply curve is vertical SS, when price is Pe and quantity supplied
is Qe.
With a given price increase to P1, there will be no change in the short-
run in quantity supplied; it will remain at Qe. Given same time for
adjustment, the supply curve will rotate at price Pe to S1S1. The new
quantity supplied will shift out to Q1 at P1. Finally, the long- run supply
curve is shown by S2S2. The quantity supplied again increases to Q2 at
P1 and so on.
Elasticity of Demand and Supply # 16. Determinants of
Supply Elasticity:
Supply elasticities are very important in economics.

As with demand there are a number of factors which affect

elasticity of supply:
(a) Time:
This is the most significant factor as we have seen how elasticity
increases with time.

(b) Factor Mobility:

The ease with which factors of production can be moved from one use
to another will affect elasticity of supply. The higher the factor
mobility, the greater will be the elasticity of supply.

(c) Natural Constraints:

Nature would place restrictions upon supply. If, for example we wish
to produce more vintage wine it will take years to mature before it
becomes vintage.

(d) Risk-Taking:
The more willing entrepreneurs are to take risks, the greater will be
the elasticity of supply. This will be partly influenced by the system of
incentives in the economy. If, for example, marginal rate of tax is very
high, it may reduce the elasticity of supply.

(e) Costs:
Elasticity of supply depends to a great extent on how costs change as
output is varied. If unit costs rise rapidly as output rises, then the
stimulus to expand production in response to a price rise will quickly
be choked-off by those increases in costs that occur as output
increases. In this case, supply will rather be inelastic.

If, on the other hand, unit costs rise only slowly as production
increases, a rise in price that raises profits will call forth a large
increase in quantity supplied before the rise in costs puts a halt to the
expansion in output In this case, supply will tend to be rather elastic.